XNAS:PMTC Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________
FORM 10-Q
____________________________________________________
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
Commission File Number: 0-18059
____________________________________________________
Parametric Technology Corporation
(Exact name of registrant as specified in its charter)
____________________________________________________
Massachusetts
 
04-2866152
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
140 Kendrick Street, Needham, MA 02494
(Address of principal executive offices, including zip code)
(781) 370-5000
(Registrant’s telephone number, including area code)
 ____________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer
þ
  
Accelerated filer
¨
  
Non-accelerated filer
¨
  
Smaller reporting company
¨
 
 
  
 
 
  
(Do not check if a smaller
reporting company)
  
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
There were 119,575,472 shares of our common stock outstanding on May 4, 2012.




PARAMETRIC TECHNOLOGY CORPORATION
INDEX TO FORM 10-Q
For the Quarter Ended March 31, 2012

 
 
Page
Number
Part I—FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
Part II—OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 5.
Item 6.


2


PART I—FINANCIAL INFORMATION

ITEM 1.
UNAUDITED CONDENSED FINANCIAL STATEMENTS

PARAMETRIC TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(unaudited)
 
 
March 31,
2012
 
September 30,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
224,107

 
$
167,878

Accounts receivable, net of allowance for doubtful accounts of $3,313 and $3,902 at March 31, 2012 and September 30, 2011, respectively
204,437

 
230,220

Prepaid expenses
32,398

 
30,582

Other current assets
116,190

 
109,433

Deferred tax assets
54,128

 
54,151

Total current assets
631,260

 
592,264

Property and equipment, net
64,021

 
62,569

Goodwill
616,599

 
613,394

Acquired intangible assets, net
205,128

 
222,017

Deferred tax assets
112,092

 
98,064

Other assets
29,516

 
41,374

Total assets
$
1,658,616

 
$
1,629,682

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
17,961

 
$
16,974

Accrued expenses and other current liabilities
54,187

 
60,167

Accrued compensation and benefits
88,799

 
95,980

Accrued income taxes
17,094

 
11,895

Deferred tax liabilities
1,178

 
4,440

Deferred revenue
327,313

 
279,935

Total current liabilities
506,532

 
469,391

Revolving credit facility
160,000

 
200,000

Deferred tax liabilities
23,830

 
25,919

Deferred revenue
14,041

 
14,389

Other liabilities
96,220

 
97,293

Total liabilities
800,623

 
806,992

Commitments and contingencies (Note 13)

 

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

 

Common stock, $0.01 par value; 500,000 shares authorized; 119,487 and 116,937 shares issued and outstanding at March 31, 2012 and September 30, 2011, respectively
1,195

 
1,169

Additional paid-in capital
1,810,964

 
1,805,021

Accumulated deficit
(893,043
)
 
(918,736
)
Accumulated other comprehensive loss
(61,123
)
 
(64,764
)
Total stockholders’ equity
857,993

 
822,690

Total liabilities and stockholders’ equity
$
1,658,616

 
$
1,629,682






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


3


PARAMETRIC TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
Revenue:
 
 
 
 
 
 
 
License
$
74,779

 
$
74,215

 
$
163,867

 
$
149,688

Service
226,346

 
194,974

 
455,534

 
386,053

Total revenue
301,125

 
269,189

 
619,401

 
535,741

Cost of revenue:
 
 
 
 
 
 
 
Cost of license revenue
7,824

 
6,558

 
15,483

 
12,512

Cost of service revenue
85,392

 
75,213

 
175,952

 
155,320

Total cost of revenue
93,216

 
81,771

 
191,435

 
167,832

Gross margin
207,909

 
187,418

 
427,966

 
367,909

Sales and marketing
90,962

 
81,163

 
188,740

 
165,684

Research and development
54,576

 
53,051

 
109,569

 
104,573

General and administrative
29,534

 
24,712

 
59,106

 
48,196

Amortization of acquired intangible assets
5,132

 
4,266

 
10,341

 
8,120

Restructuring charges
20,802

 

 
20,802

 

Total operating expenses
201,006

 
163,192

 
388,558

 
326,573

Operating income
6,903

 
24,226

 
39,408

 
41,336

Interest and other (expense) income, net
(2,967
)
 
(822
)
 
(5,610
)
 
(2,708
)
Income before income taxes
3,936

 
23,404

 
33,798

 
38,628

Provision for income taxes
367

 
4,387

 
8,106

 
6,351

Net income
$
3,569

 
$
19,017

 
$
25,692

 
$
32,277

Earnings per share—Basic
$
0.03

 
$
0.16

 
$
0.22

 
$
0.27

Earnings per share—Diluted
$
0.03

 
$
0.16

 
$
0.21

 
$
0.27

Weighted average shares outstanding—Basic
119,003

 
118,194

 
118,356

 
117,501

Weighted average shares outstanding—Diluted
121,401

 
121,502

 
120,985

 
121,317















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

4


PARAMETRIC TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
 
 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
Net income
$
3,569

 
$
19,017

 
$
25,692

 
$
32,277

Other comprehensive income (loss), net of tax:
 
 
 
 

 

Foreign currency translation adjustment, net of tax of $0 for all periods
7,849

 
11,264

 
2,779

 
8,273

Minimum pension liability adjustment, net of tax of $0.3 million for both the second quarter and first six months of 2012 and ($0.2) million and ($0.1) million for the second quarter and first six months of 2011, respectively
717

 
(385
)
 
862

 
(266
)
Other comprehensive income
8,566

 
10,879

 
3,641

 
8,007

Comprehensive income
$
12,135

 
$
29,896

 
$
29,333

 
$
40,284



































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


5


PARAMETRIC TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Six months ended
 
March 31,
2012
 
April 2,
2011
Cash flows from operating activities:
 
 
 
Net income
$
25,692

 
$
32,277

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
33,285

 
28,720

Stock-based compensation
26,074

 
20,898

Excess tax benefits from stock-based awards
(453
)
 
(530
)
Other non-cash costs, net
211

 
154

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
38,698

 
15,899

Accounts payable and accrued expenses
(6,233
)
 
2,089

Accrued compensation and benefits
(7,635
)
 
(27,406
)
Deferred revenue
33,482

 
27,169

Accrued litigation

 
(52,129
)
Accrued income taxes
(11,901
)
 
(9,198
)
Other current assets and prepaid expenses
3,573

 
2,165

Other noncurrent assets and liabilities
(1,759
)
 
(9,870
)
Net cash provided by operating activities
133,034

 
30,238

Cash flows from investing activities:
 
 
 
Additions to property and equipment
(16,624
)
 
(11,560
)
Acquisitions of businesses
(1,170
)
 

Net cash used by investing activities
(17,794
)
 
(11,560
)
Cash flows from financing activities:
 
 
 
Borrowings under revolving credit facility
40,000

 

Repayments of borrowings under revolving credit facility
(80,000
)
 

Repurchases of common stock
(14,983
)
 

Proceeds from issuance of common stock
14,123

 
15,974

Excess tax benefits from stock-based awards
453

 
530

Payments of withholding taxes in connection with vesting of stock-based awards
(19,465
)
 
(21,956
)
Net cash used by financing activities
(59,872
)
 
(5,452
)
Effect of exchange rate changes on cash and cash equivalents
861

 
6,025

Net increase in cash and cash equivalents
56,229

 
19,251

Cash and cash equivalents, beginning of period
167,878

 
240,253

Cash and cash equivalents, end of period
$
224,107

 
$
259,504







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

6


PARAMETRIC TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
General
The accompanying unaudited condensed consolidated financial statements include the accounts of Parametric Technology Corporation (PTC) and its wholly owned subsidiaries and have been prepared by management in accordance with accounting principles generally accepted in the United States of America and in accordance with the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. While we believe that the disclosures presented are adequate in order to make the information not misleading, these unaudited quarterly financial statements should be read in conjunction with our annual consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair statement of our financial position, results of operations and cash flows at the dates and for the periods indicated. Unless otherwise indicated, all references to a year mean our fiscal year, which ends on September 30. The September 30, 2011 consolidated balance sheet included herein is derived from our audited consolidated financial statements.
The results of operations for the three and six months ended March 31, 2012 are not necessarily indicative of the results expected for the remainder of the fiscal year.

Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-8, Intangibles-Goodwill and Other (Topic 350):Testing Goodwill for Impairment. Under the update, an entity has the option, but is not required, to first assess qualitative factors (“Qualitative Assessment” or QA”) to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. If, after assessing facts and circumstances in the aggregate, an entity determines it does not fail the QA, then performing the traditional two-step impairment test is unnecessary. Otherwise, an entity is required to proceed to the first step of the goodwill impairment test as outlined in ASC Topic 350. The objective of the Update is to simplify the requirement to test goodwill for impairment and was issued in response to preparer concerns about the cost and complexity of performing the first step of the two-step goodwill impairment test. The Update can be applied for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted.

2. Deferred Revenue and Financing Receivables
Deferred Revenue
Deferred revenue primarily relates to software maintenance agreements billed to customers for which the services have not yet been provided. The liability associated with performing these services is included in deferred revenue and, if not yet paid, the related customer receivable is included in other current assets. Billed but uncollected maintenance-related amounts included in other current assets at March 31, 2012 and September 30, 2011 were $105.4 million and $93.0 million, respectively.
Financing Receivables
We periodically provide extended payment terms for software purchases to credit-worthy customers with payment terms up to 24 months. The determination of whether to offer such payment terms is based on the size, nature and credit-worthiness of the customer, and the history of collecting amounts due, without concession, from the customer and customers generally. This determination is based on an internal credit assessment. In making this assessment, we use the Standard & Poor's (S&P) credit rating as our primary credit quality indicator, if available. If a customer, including both commercial and U.S. Federal government, has a S&P bond rating of BBB- or above, we designate the customer as a Tier 1. If a customer does not have a S&P bond rating, or has a S&P bond rating below BBB-, we base our assessment on an internal credit assessment which considers selected balance sheet, operating and liquidity measures, historical payment experience, and current business conditions within the industry or region. We designate these customers as Tier 2 or Tier 3, with Tier 3 being lower credit quality than Tier 2.

As of March 31, 2012 and September 30, 2011, amounts due from customers for contracts with original payment terms greater than twelve months (financing receivables) totaled $35.0 million and $57.7 million, respectively. Accounts receivable in

7


the accompanying consolidated balance sheets included current receivables from such contracts totaling $26.4 million and $41.7 million at March 31, 2012 and September 30, 2011, respectively, and other assets in the accompanying consolidated balance sheets included long-term receivables from such contracts totaling $8.6 million and $16.0 million at March 31, 2012 and September 30, 2011, respectively. As of March 31, 2012, $1.0 million of these receivables were past due (of which $0.3 million was greater than 90 days past due). None of these receivables were past due as of September 30, 2011. Our credit risk assessment for financing receivables was as follows:

 
March 31,
2012
 
September 30,
2011
 
(in thousands)
S&P bond rating BBB-1 and above-Tier 1
$
22,143

 
$
36,639

Internal Credit Assessment-Tier 2
12,089

 
19,293

Internal Credit Assessment-Tier 3
809

 
1,798

Total financing receivables
$
35,041

 
$
57,730

 

We evaluate the need for an allowance for doubtful accounts for estimated losses resulting from the inability of these customers to make required payments. As of March 31, 2012 and September 30, 2011, we concluded that all financing receivables were collectible and no reserve for credit losses was recorded. We did not provide a reserve for credit losses or write off any uncollectible financing receivables in the six months ended March 31, 2012 and fiscal year 2011. We write off uncollectible trade and financing receivables when we have exhausted all collection avenues.

We periodically transfer future payments under certain of these contracts to third-party financial institutions on a non-recourse basis. We record such transfers as sales of the related accounts receivable when we surrender control of such receivables. We sold $1.2 million of financing receivables to third-party financial institutions in the six months ended March 31, 2012. We sold no financing receivables to third-party financial institutions in the six months ended April 2, 2011.

3. Restructuring Charges

In the second quarter of 2012, as part of our strategy to reduce costs and to realign our business, we implemented a restructuring of our business and recorded restructuring charges of $20.8 million. The restructuring charges included $20.0 million for severance and related costs associated with 168 employees notified of termination during the second quarter of 2012 and $0.8 million of charges related to excess facilities. The employee terminations triggered a curtailment of a non-U.S. pension plan and interim remeasurement of the pension plan's assets and liabilities. The remeasurement resulted in a decrease in the plan's net unrecognized losses of $1.2 million, which was recorded in accumulated other comprehensive income net of tax.

The following table summarizes restructuring accrual activity for the period ended March 31, 2012:
 
 
Employee Severance and Related Benefits
 
Facility Closures and Related Costs
 
Total
 
 
(in thousands)
Restructuring charge activity for the three months ended March 31, 2012
 
 
 
 
 
 
Charges to operations
 
$
19,953

 
$
849

 
$
20,802

Cash disbursements
 
(8,829
)
 
(68
)
 
(8,897
)
Foreign exchange impact
 
150

 
5

 
155

Accrual, March 31, 2012
 
$
11,274

 
$
786

 
$
12,060


The accrual for facility closures and related costs is included in accrued expenses in the consolidated balance sheet, and the accrual for employee severance and related benefits is included in accrued compensation and benefits in the consolidated balance sheet. The facility accrual remaining at March 31, 2012 is related to excess space in a facility representing a gross lease commitment of approximately $1.6 million, net of assumed replacement tenant income of approximately $0.8 million.

8





4. Stock-based Compensation
We measure the cost of employee services received in exchange for restricted stock and restricted stock unit (RSU) awards based on the fair value of our common stock on the date of grant. That cost is recognized over the period during which an employee is required to provide service in exchange for the award.
Our equity incentive plan provides for grants of nonqualified and incentive stock options, common stock, restricted stock, RSUs and stock appreciation rights to employees, directors, officers and consultants. We award restricted stock and RSUs as the principal equity incentive awards, including certain performance-based awards that are earned based on achievement of performance criteria established by the Compensation Committee of our Board of Directors. Each RSU represents the contingent right to receive one share of our common stock.
Our equity incentive plans are described more fully in Note K to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011.

Restricted stock activity for the six months ended March 31, 2012
Shares
 
Weighted
Average
Grant Date
Fair Value
(Per Share)
 
(in thousands)
 
 
Balance of outstanding restricted stock September 30, 2011
90

 
$
21.30

Granted
57

 
$
25.27

Vested
(63
)
 
$
21.13

Balance of outstanding restricted stock March 31, 2012
84

 
$
24.11

Restricted stock unit activity for the six months ended March 31, 2012
Shares
 
Weighted
Average
Grant Date
Fair Value
(Per Share)
 
(in thousands)
 
 
Balance of outstanding restricted stock units September 30, 2011
5,490

 
$
17.75

Granted
1,926

 
$
19.82

Vested
(2,538
)
 
$
15.59

Forfeited or not earned
(293
)
 
$
18.56

Balance of outstanding restricted stock units March 31, 2012
4,585

 
$
19.77

Restricted stock and restricted stock unit grants in the first six months of 2012
 
 
Restricted Stock
 
Restricted Stock Units
Grant Period
Performance-based
 
Time-based (1)
 
Performance-based (2)
 
Time-based (3)
 
(in thousands)
 
(Number of Shares)
 
(Number of Units)
First six months of 2012
 
57
 
780
 
1,146
_________________
(1)
Of the time-based shares of restricted stock, 9,402 were issued to a non-employee director in connection with a consulting contract we entered into with him. The restrictions on these shares lapse in two substantially equal annual installments from the date of grant. The remaining 47,177 were issued to non-employee directors. The restrictions on these shares lapse one year from the date of grant.
(2)
Of these performance-based RSUs, 11,899 will be eligible to vest on the later of November 15, 2012 and the date the Compensation Committee determines the extent to which the performance criteria have been achieved and 425,698 will be eligible to vest in three substantially equal installments on the later of November 15, 2012 and the date the Compensation Committee determines the extent to which performance criteria have been achieved, November 15, 2013 and November 15, 2014; and 309,976 are eligible to vest in two substantially equal installments on the later of each of November 15, 2013 and November 15, 2014 and the date the Compensation Committee determines the extent to which the applicable performance criteria have been achieved (RSUs not earned for 2013 may be earned for 2014 to the extent the cumulative performance criteria are achieved). The remaining 32,508 have been forfeited.

9


(3)
The time-based RSUs were issued to employees, including some of our executive officers. These time-based RSUs will vest in three substantially equal annual installments in November 2012, 2013 and 2014.
Compensation expense recorded for our stock-based awards was classified in our consolidated statements of operations as follows:
 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands)
 
(in thousands)
Cost of license revenue
$
7

 
$
3

 
$
12

 
$
6

Cost of service revenue
2,171

 
1,583

 
4,684

 
3,720

Sales and marketing
3,306

 
2,350

 
7,034

 
4,779

Research and development
2,240

 
1,749

 
4,789

 
4,142

General and administrative
4,968

 
4,186

 
9,555

 
8,251

Total stock-based compensation expense
$
12,692

 
$
9,871

 
$
26,074

 
$
20,898


5. Earnings per Share (EPS) and Common Stock
EPS
Basic EPS is calculated by dividing net income by the weighted average number of shares outstanding during the period. Unvested restricted stock, although legally issued and outstanding, is not considered outstanding for purposes of calculating basic EPS. Diluted EPS is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding stock options, restricted shares and RSUs using the treasury stock method. The calculation of the dilutive effect of outstanding equity awards under the treasury stock method includes consideration of proceeds from the assumed exercise of stock options, unrecognized compensation expense and any tax benefits as additional proceeds.

 
 
Three months ended
 
Six months ended
Calculation of Basic and Diluted EPS
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands, except per share data)
Net income
$
3,569

 
$
19,017

 
$
25,692

 
$
32,277

Weighted average shares outstanding—Basic
119,003

 
118,194

 
118,356

 
117,501

Dilutive effect of employee stock options, restricted shares and restricted stock units
2,398

 
3,308

 
2,629

 
3,816

Weighted average shares outstanding—Diluted
121,401

 
121,502

 
120,985

 
121,317

Earnings per share—Basic
$
0.03

 
$
0.16

 
$
0.22

 
$
0.27

Earnings per share—Diluted
$
0.03

 
$
0.16

 
$
0.21

 
$
0.27


Stock options to purchase 0.2 million and 0.1 million shares for the second quarter and first six months of 2012, respectively, and 0.1 million shares for both the second quarter and first six months of 2011 were outstanding but were not included in the calculation of diluted EPS because the exercise prices per share were greater than the average market price of our common stock for those periods. These shares were excluded from the computation of diluted EPS as the effect would have been anti-dilutive.
Common Stock Repurchases
Our Articles of Organization authorize us to issue up to 500 million shares of our common stock. Our Board of Directors has authorized us to repurchase up to $100 million worth of shares with cash from operations in the period October 1, 2011 through September 30, 2012. In the second quarter and first six months of 2012, we repurchased 0.6 million shares at a cost of $15.0 million. We did not repurchase any shares in the first six months of 2011. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.

10


6. Acquisitions
In 2011, we completed the acquisitions of MKS and 4CS described more fully in Note E to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011. The results of operations of these acquired businesses have been included in our consolidated financial statements beginning on their respective acquisition dates. These acquisitions added $22.3 million and $40.7 million to our revenue for the three and six months ended March 31, 2012, respectively.
Acquisition-related costs were $0.4 million and $2.5 million for the three and six months ended March 31, 2012, respectively, and include charges related to acquisition integration activities (i.e., severance and professional fees). These costs have been classified in general and administrative expenses in the accompanying consolidated statements of operations.
4CS
On September 2, 2011, we acquired all of the outstanding common stock of 4C Solutions, Inc. (4CS) for $14.9 million in cash (net of $0.1 million of cash acquired). 4CS's results of operations have been included in our consolidated financial statements beginning September 3, 2011. Our results of operations prior to this acquisition, if presented on a pro forma basis, would not differ materially from our reported results.
As of September 30, 2011, we had recorded a liability for an additional $1.2 million of contingent purchase price included in accrued expenses and other current liabilities on the consolidated balance sheet. In the six months ended March 31, 2012, this amount was fully earned and paid. Any further adjustments that could lower the purchase price in accordance with contingent provisions in the acquisition agreement are not anticipated to be material.

MKS
On May 31, 2011, we acquired all of the outstanding common stock of MKS Inc. (MKS) for $265.2 million, net of $33.2 million of cash acquired. MKS's results of operations have been included in our consolidated financial statements beginning May 31, 2011.
The unaudited financial information in the table below summarizes the combined results of operations of PTC and MKS, on a pro forma basis, as though the companies had been combined as of the beginning of PTC's fiscal year 2010. The pro forma information presented includes the effects of business combination accounting resulting from the acquisition, including amortization charges from acquired intangibles assets, stock-based compensation charges for unvested stock options, interest expense on borrowings in connection with the acquisition, and the related tax effects as though the acquisition had been consummated as of the beginning of 2010. These pro forma results exclude the impact of the purchase accounting adjustment to deferred revenue and the transaction costs included in the historical results and the related tax effects. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisition had taken place at the beginning of 2010. The pro forma financial information is based on PTC's results of operations for the three and six months ended April 2, 2011, combined with MKS's results of operations for the three and six months ended April 30, 2011 (due to differences in reporting periods).

 
Three months ended
 
Six months ended
 
April 2,
2011
 
April 2,
2011
 
(in millions, except per share amounts)
Revenue
$
297.2

 
$
581.7

Net income
$
22.9

 
$
35.4

Earnings per share—Basic
$
0.19

 
$
0.30

Earnings per share—Diluted
$
0.19

 
$
0.29


7. Goodwill and Intangible Assets
We have two reportable segments: (1) software products and (2) services. As of March 31, 2012 and September 30, 2011, goodwill and acquired intangible assets in the aggregate attributable to our software products reportable segment was $792.9 million and $806.0 million, respectively, and attributable to our services reportable segment was $28.8 million and $29.4 million, respectively. Goodwill is tested for impairment at least annually, or on an interim basis if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting segment below its carrying value. We completed our most recent annual impairment review as of July 2, 2011 and concluded that no impairment charge was

11


required as of that date. Acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.
Goodwill and acquired intangible assets consisted of the following:
 
 
March 31, 2012
 
September 30, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
(in thousands)
Goodwill (not amortized)
 
 
 
 
$
616,599

 
 
 
 
 
$
613,394

Intangible assets with finite lives (amortized) (1):
 
 
 
 
 
 
 
 
 
 
 
Purchased software
$
178,658

 
$
120,584

 
58,074

 
$
178,388

 
$
112,555

 
$
65,833

Capitalized software
22,877

 
22,877

 

 
22,877

 
22,877

 

Customer lists and relationships
229,175

 
84,735

 
144,440

 
227,961

 
75,050

 
152,911

Trademarks and trade names
11,079

 
8,587

 
2,492

 
11,035

 
7,967

 
3,068

Other
3,500

 
3,378

 
122

 
3,506

 
3,301

 
205

 
$
445,289

 
$
240,161

 
$
205,128

 
$
443,767

 
$
221,750

 
$
222,017

Total goodwill and acquired intangible assets
 
 
 
 
$
821,727

 
 
 
 
 
$
835,411


(1) The weighted average useful lives of purchased software, customer lists and relationships, trademarks and trade names and other intangible assets with a remaining net book value are 8 years, 10 years, 6 years, and 4 years, respectively.

Goodwill
The changes in the carrying amounts of goodwill for the six months ended March 31, 2012 are due to foreign currency translation adjustments related to those asset balances that are recorded in non-U.S. currencies.
Changes in goodwill for the six months ended March 31, 2012, presented by reportable segment, are as follows:

 
Software
Products
Segment
 
Services
Segment
 
Total
 
(in thousands)
Balance, September 30, 2011
$
588,443

 
$
24,951

 
$
613,394

Foreign currency translation adjustments
3,211

 
(6
)
 
3,205

Balance, March 31, 2012
$
591,654

 
$
24,945

 
$
616,599


Amortization of intangible assets
The aggregate amortization expense for intangible assets with finite lives recorded for the second quarter and first six months of 2012 and 2011 was classified in our consolidated statements of operations as follows:

 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands)
 
 
 
 
Amortization of acquired intangible assets
$
5,132

 
$
4,266

 
$
10,341

 
$
8,120

Cost of license revenue
3,931

 
3,339

 
8,034

 
6,702

Total amortization expense
$
9,063

 
$
7,605

 
$
18,375

 
$
14,822


The estimated aggregate future amortization expense for intangible assets with finite lives remaining as of March 31,

12


2012 is $18.1 million for the remainder of 2012, $36.4 million for 2013, $34.3 million for 2014, $30.8 million for 2015, $23.2 million for 2016, $19.6 million for 2017 and $42.6 million thereafter.

8. Fair Value Measurements
Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. Generally accepted accounting principles prescribe a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs that may be used to measure fair value:
Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or
Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Our significant financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and September 30, 2011 were as follows:

 
March 31,
2012
 
September 30,
2011
 
(in thousands)
Financial assets:
 
 
 
Cash equivalents—Level 1 (1)
$
67,650

 
$
36,018

Forward contracts—Level 2
197

 
5,510

 
$
67,847

 
$
41,528

_________________
(1)
Money market funds and time deposits.


9. Derivative Financial Instruments
Our foreign currency risk management strategy is principally designed to mitigate the future potential financial impact of changes in the value of transactions and balances denominated in foreign currency resulting from changes in foreign currency exchange rates. We enter into derivative transactions, specifically foreign currency forward contracts with maturities of up to three months, to manage our exposure to fluctuations in foreign exchange rates that arise primarily from our foreign currency-denominated receivables and payables.
Generally, we do not designate foreign currency forward contracts as hedges for accounting purposes, and changes in the fair value of these instruments are recognized immediately in earnings. Because we enter into forward contracts only as an economic hedge, any gain or loss on the underlying foreign-denominated balance would be offset by the loss or gain on the forward contract. Gains and losses on forward contracts and foreign denominated receivables and payables are included in other income (expense), net.

13


As of March 31, 2012 and September 30, 2011, we had outstanding forward contracts with notional amounts equivalent to the following:

Currency Hedged
March 31,
2012
 
September 30,
2011
 
(in thousands)
Canadian Dollar / U.S. Dollar
$
64,274

 
$
92,748

Euro / U.S. Dollar
38,888

 
65,773

Canadian Dollar / Euro
4,781

 

Chinese Renminbi / U.S. Dollar
5,480

 
19,973

Japanese Yen / U.S. Dollar
22,150

 
13,676

Swiss Franc / U.S. Dollar
9,167

 
9,419

British Pound / Euro
5,706

 
3,993

All other
10,365

 
7,350

Total
$
160,811

 
$
212,932



The accompanying consolidated balance sheets as of March 31, 2012 and September 30, 2011 include a net asset of $0.2 million and $5.5 million, respectively, in other current assets related to the fair value of our forward contracts.
Net gains and losses on foreign currency exposures, including realized and unrealized gains and losses on forward contracts, included in foreign currency net losses, were net losses of $2.4 million and $4.6 million for the three and six months ended March 31, 2012, respectively, and $1.1 million and $3.3 million for the three and six months ended April 2, 2011, respectively. Excluding the underlying foreign currency exposure being hedged, net realized and unrealized gains and losses on forward contracts included in foreign currency net losses, were net losses of $1.7 million and $2.4 million for the three and six months ended March 31, 2012, respectively, and net losses of $6.5 million and $5.2 million for the three and six months ended April 2, 2011, respectively.

10. Segment Information
We operate within a single industry segment—computer software and related services. Operating segments as defined under GAAP are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our President and Chief Executive Officer. We have two operating and reportable segments: (1) Software Products, which includes license and related maintenance revenue (including updates and technical support) for all our products except training-related products; and (2) Services, which includes consulting, implementation, training, computer-based training products, including maintenance on these products, and other support revenue. In our consolidated statements of operations, maintenance revenue is included in service revenue. We do not allocate sales and marketing or administrative expenses to our operating segments as these activities are managed on a consolidated basis.

14


The revenue and operating income attributable to our operating segments are summarized as follows:

 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
Total Software Products segment revenue
$
221,653

 
$
203,156

 
$
458,616

 
$
405,066

Total Services segment revenue
79,472

 
66,033

 
160,785

 
130,675

Total revenue
$
301,125

 
$
269,189

 
$
619,401

 
$
535,741

Operating income: (1)
 
 
 
 
 
 
 
Software Products segment
$
128,343

 
$
125,205

 
$
280,302

 
$
251,724

Services segment (2)
7,959

 
4,896

 
15,854

 
3,492

Sales and marketing expenses
(98,248
)
 
(81,163
)
 
(196,025
)
 
(165,684
)
General and administrative expenses
(31,151
)
 
(24,712
)
 
(60,723
)
 
(48,196
)
Total operating income
$
6,903

 
$
24,226

 
$
39,408

 
$
41,336


(1)
We recorded restructuring charges of $20.8 million in the second quarter of 2012. Software Products included $9.2 million; Services included $2.7 million; sales and marketing expenses included $7.3 million; and general and administrative expenses included $1.6 million of these restructuring charges.
(2)
In the first quarter of 2011, we made a strategic decision to enter into a contract with a customer in the automotive industry, for which we expected our costs to exceed our revenue by approximately $5 million. Services segment operating income in the first three months of 2011 included immediate recognition of the approximately $5 million estimated loss on this contract.
We report revenue by product group, Desktop and Enterprise. Desktop revenue includes our CAD Solutions, primarily: Creo Parametric, Creo Elements/Direct, Mathcad and Arbortext authoring products. Enterprise revenue includes our PLM solutions, primarily: Windchill, Arbortext enterprise products, Creo View and Integrity.

 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
Desktop
$
147,751

 
$
154,839

 
$
301,614

 
$
300,800

Enterprise
153,374

 
114,350

 
317,787

 
234,941

Total revenue
$
301,125

 
$
269,189

 
$
619,401

 
$
535,741


Data for the geographic regions in which we operate is presented below.

 
Three months ended
 
Six months ended
 
March 31,
2012
 
April 2,
2011
 
March 31,
2012
 
April 2,
2011
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
Americas (1)
$
109,483

 
$
94,399

 
$
226,973

 
$
194,492

Europe (2)
115,780

 
105,955

 
248,955

 
213,831

Pacific Rim
37,373

 
36,208

 
74,623

 
69,820

Japan
38,489

 
32,627

 
68,850

 
57,598

Total revenue
$
301,125

 
$
269,189

 
$
619,401

 
$
535,741

_________________
(1)
Includes revenue in the United States totaling $102.3 million and $89.9 million for the three months ended March 31,

15


2012 and April 2, 2011, respectively, and $213.0 million and $185.3 million for the six months ended March 31, 2012 and April 2, 2011, respectively.
(2)
Includes revenue in Germany totaling $41.2 million and $38.5 million for the three months ended March 31, 2012 and April 2, 2011, respectively, and $97.4 million and $71.8 million for the six months ended March 31, 2012 and April 2, 2011, respectively.

11. Income Taxes
In the second quarter and first six months of 2012, our effective tax rate was a provision of 9% on pre-tax income of $3.9 million, and 24% on pre-tax income of $33.8 million, respectively, compared to a provision of 19% on pre-tax income of $23.4 million and 16% on pre-tax income of $38.6 million in the second quarter and first six months of 2011, respectively. In the first six months of 2012, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate. Our provision includes the expiration on December 31, 2011 of the research and development (R&D) credit in the U.S. and a discrete non-cash charge of $1.5 million related to the impact of a Japanese legislative change, enacted in the first quarter, on our Japan entity's deferred tax assets. Additionally, we expect to make an R&D cost sharing prepayment by a foreign subsidiary to the U.S. at the same level as the prior year. If such prepayment is not ultimately paid within the fiscal year, the effective tax rate would be favorably impacted by up to $7.5 million. In the first six months of 2011, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate tax structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate and a $1.8 million tax benefit related to R&D credits in the U.S. triggered by a retroactive extension of the R&D tax credit enacted in the first quarter of 2011.
As of March 31, 2012 and September 30, 2011, we had unrecognized tax benefits of $17.4 million ($17.0 million net of state tax benefits) and $16.2 million ($15.9 million net of state tax benefits), respectively. If all of our unrecognized tax benefits as of March 31, 2012 were to become recognizable in the future, we would record a $16.3 million benefit to the income tax provision.
Our policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of our income tax provision. In the first six months of 2012 and 2011 we included $0.1 million and $0.2 million of interest expense, respectively, and no tax penalty expense in our income tax provision. As of March 31, 2012 and September 30, 2011 we had accrued $2.1 million and $2.0 million, respectively, of estimated interest expense and we had no accrued tax penalties. Changes in our unrecognized tax benefits in the six months ended March 31, 2012 were as follows:

 
(in millions)
Balance as of October 1, 2011
$
16.2

Tax positions related to current year
1.2

Tax positions related to prior years

Balance as of March 31, 2012
$
17.4


Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in favorable or unfavorable changes in our estimates. We believe it is reasonably possible that within the next 12 months the amount of unrecognized tax benefits and accrued interest related to the resolution of multi-jurisdictional tax positions could be reduced by up to $7 million as audits close and statutes expire.
In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service in the United States. As of March 31, 2012, we remained subject to examination in the following major tax jurisdictions for the tax years indicated:

Major Tax Jurisdiction
  
Open Years
United States
  
2003, 2008 through 2011
Germany
  
2007 through 2011
France
  
2007 through 2011
Japan
  
2005 through 2011
Ireland
  
2006 through 2011

16



12. Long Term Debt
Revolving Credit Agreement
We have a multi-currency bank revolving credit facility (the credit facility) with a syndicate of ten banks for which JPMorgan Chase Bank, N.A. acts as Administrative Agent. The credit facility matures on September 30, 2016, when all amounts will be due and payable in full. The credit facility does not require amortization of principal and may be paid before maturity in whole or in part at PTC’s option without penalty or premium. We expect to use the credit facility for general corporate purposes, including acquisitions of other businesses, and may also use it for working capital.
The credit facility consists of a $300 million revolving credit facility, which may be increased by up to an additional $150 million if the existing or additional lenders are willing to make such increased commitments (such increase may also be used, in whole or in part, for term loans). PTC is the sole borrower under the credit facility. The obligations under the credit facility are guaranteed by PTC’s material domestic subsidiaries and 65% of the voting equity interests of PTC’s material first-tier foreign subsidiaries are pledged as collateral for the obligations.
In May 2011, in connection with our acquisition of MKS, we borrowed $250 million under the credit facility at a variable interest rate which resets every 30 to 180 days, depending on the rate and period selected. From October 1, 2011 through November 21, 2011, the annual rate was 1.6875%. From November 22, 2011 through May 22, 2012 the annual rate is 1.875%, which will reset on May 22, 2012 to then current rates as defined below. As of March 31, 2012 and September 30, 2011 we had $160 million and $200 million, respectively, outstanding under the credit facility. During the three months ended December 31, 2011, we borrowed and then repaid $40 million under the credit facility for short term cash requirements. During the three months ended March 31, 2012, we repaid $40 million under the credit facility.
Interest rates on borrowings outstanding under the credit facility range from 1.25% to 1.625% above an adjusted LIBO rate for Eurodollar-based borrowings or would range from 0.25% to 0.625% above the defined base rate (the greater of the Prime Rate, the Federal Funds Effective Rate plus 0.005%, or an adjusted LIBO rate plus 1%) for base rate borrowings, in each case based upon PTC’s leverage ratio. Additionally, PTC may borrow certain foreign currencies at rates set in the same range above the respective London interbank offered interest rates for those currencies, based on PTC’s leverage ratio. A quarterly commitment fee on the undrawn portion of the credit facility is required, ranging from 0.20% to 0.30% per annum, based upon PTC’s leverage ratio.
The credit facility limits PTC’s and its subsidiaries’ ability to, among other things: incur additional indebtedness; incur liens or guarantee obligations; pay dividends (other than to PTC) and make other distributions; make investments and enter into joint ventures; dispose of assets; and engage in transactions with affiliates, except on an arms-length basis. Under the credit facility, PTC and its material domestic subsidiaries may not invest cash or property in, or loan to, PTC’s foreign subsidiaries in aggregate amounts exceeding $50 million for any purpose and an additional $75 million for acquisitions of businesses. In addition, under the credit facility, PTC and its subsidiaries must maintain the following financial ratios:
a leverage ratio, defined as consolidated funded indebtedness to consolidated trailing four quarters EBITDA, of no greater than 2.50 to 1.00 at any time; and
a fixed charge coverage ratio, defined as the ratio of consolidated trailing four quarters EBITDA less consolidated capital expenditures to consolidated fixed charges, of no less than 1.25 to 1.00 at any time.

As of March 31, 2012, our leverage ratio was 0.65 to 1.00 and our fixed charge coverage ratio was 2.82 to 1.00. We were in compliance with all financial and operating covenants of the credit facility as of March 31, 2012.
Any failure to comply with the financial or operating covenants of the credit facility would prevent PTC from being able to borrow additional funds, and would constitute a default, permitting the lenders to, among other things, accelerate the amounts outstanding, including all accrued interest and unpaid fees, under the credit facility and to terminate the credit facility. A change in control of PTC, as defined in the agreement, also constitutes an event of default, permitting the lenders to accelerate the indebtedness and terminate the credit facility.

13. Commitments and Contingencies

Legal and Regulatory Matters

China Investigation

We have undertaken an investigation of payments by certain business partners and expenses by certain employees in China that raise questions of compliance with laws, including the Foreign Corrupt Practices Act, and/or compliance with our

17


business policies. The termination of certain employees and business partners in China in connection with this matter may have an adverse impact on our level of sales in China until such replacements for those employees and business partners are in place and productive. Revenue from China has historically represented 6% to 7% of our total revenue. We have voluntarily disclosed the results of our investigation and associated remedial actions to the United States Department of Justice and the Securities and Exchange Commission and are cooperating to provide additional information as requested. We are unable to predict the outcome of this matter, which could include fines or other sanctions.

Other Legal Proceedings

We are subject to various legal proceedings and claims that arise in the ordinary course of business. We do not believe that resolving the legal proceedings and claims that we are currently subject to will have a material adverse impact on our financial condition, results of operations or cash flows. However, the results of legal proceedings cannot be predicted with certainty. Should any of these legal proceedings and claims be resolved against us, the operating results for a particular reporting period could be adversely affected.

Accruals

With respect to legal proceedings and claims, we record an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. For legal proceedings and claims for which the likelihood that a liability has been incurred is more than remote but less than probable, we estimate the range of possible outcomes. As of both March 31, 2012 and September 30, 2011, we had a legal proceedings and claims accrual of $0.4 million.
Guarantees and Indemnification Obligations
We enter into standard indemnification agreements in the ordinary course of our business. Pursuant to such agreements with our business partners or customers, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally in connection with patent, copyright or other intellectual property infringement claims by any third party with respect to our current products, as well as claims relating to property damage or personal injury resulting from the performance of services by us or our subcontractors. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. Historically, our costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and we accordingly believe the estimated fair value of these agreements is immaterial.
We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products for a specified period of time. Additionally, we generally warrant that our consulting services will be performed consistent with generally accepted industry standards. In most cases, liability for these warranties is capped. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history; however, we have not incurred significant cost under our product or services warranties. As a result, we believe the estimated fair value of these agreements is immaterial.

18


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, the development of our products and markets, adoption of our solutions and future purchases by customers, and the expected impact of our strategic investments and product releases on our business 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: our customers may not purchase our solutions when or at the rates we expect; we may not achieve the license, service or maintenance growth rates we expect, which could result in a different mix of revenue between license, service and maintenance and could adversely affect our profitability; the possibility that foreign currency exchange rates may vary from our expectations and thereby affect our reported revenue and expense; our strategic investments, including adding sales personnel, may not generate the revenue or have the effects we expect; we may be unable to attain or maintain a technology leadership position and any such leadership position may not generate the revenue we expect; the MKS and 4CS businesses may not generate the revenue we expect; our ability to successfully differentiate our products and services from those of our competitors and otherwise compete could be adversely affected by the relatively larger size and greater resources of several of the companies with which we compete; the possibility that remedial actions related to our previously announced investigation in China may have a material impact on our operations in China, as well as other risks and uncertainties described below throughout or referenced in Part II, Item 1A. Risk Factors of this report.
Our Business
Parametric Technology Corporation (PTC) develops, markets and supports solutions that span the entire product lifecycle, from engineering product design through supply chain and after-market services. Our software solutions provide our customers with an integral product development system that enables them to create digital product content, collaborate with others in the product development process, control product content, automate product development processes, configure products and product content, and communicate product information to people and systems across the extended enterprise and design chain.
Our solutions in the product lifecycle management, or PLM, market (product data management, collaboration and related solutions); the CAD market (computer-aided design solutions); and the application lifecycle management, or ALM, market (software development solutions within product development) help companies design products, manage product information and improve their product development processes. Our solutions in the supply chain management, or SCM, market (product sourcing, design and compliance solutions) and the service lifecycle management, or SLM, market (after-market service and support solutions) help companies manage product performance, reliability and safety and ensure that updates in product development are reflected in real-time service and spare parts information throughout a product's service lifecycle.
Our software solutions help customers increase innovation, improve product quality, decrease time to market, and reduce product development costs.
We generate revenue through the sale of:
software licenses,
maintenance services, which include technical support and software updates, and
consulting and training services, which include implementation services for our software.
The markets we serve present different growth opportunities for us. We believe the markets among large businesses for PLM, ALM, SLM and SCM solutions (which we refer to as our “Enterprise Solutions”) present the greatest opportunity for revenue growth for us and that revenue from these markets will constitute an increasingly greater proportion of our revenue over time. We believe that the market for our CAD solutions (which we refer to as our “Desktop Solutions”) provides an opportunity for modest long-term growth as the market for these solutions is mature.
Our solutions are complemented by our experienced services and technical support organizations which provide consulting, implementation and training support services to customers worldwide. Resellers supplement this direct sales force to provide greater geographic and small- and medium-size account coverage, while other strategic partners provide product and/or service offerings that complement our solutions.


19


Executive Overview

For the second quarter of 2012, our total revenue was $301 million (non-GAAP revenue was $302 million), a 12% year-over-year increase on both a reported and constant currency basis. Revenue during the quarter from our MKS and 4CS businesses, both acquired in the second half of fiscal 2011, was $22 million (non-GAAP revenue was $23 million). Excluding MKS and 4CS revenue, organic total revenue for the second quarter of 2012 was up 4% year over year. While our second quarter maintenance and consulting and training services revenues were in line with our expectations, our license revenue was below our expectations. Total license revenue for the second quarter of 2012 was $75 million, an increase of 1% year over year, but below our expectations. On an organic basis license revenue for the second quarter of 2012 was $67 million, a decrease of 10% year over year. We attribute our lower than expected license revenue to a large transaction in Europe that did not close and lower than expected sales in North America.

Our non-GAAP operating margin increased to 17% in the second quarter of 2012 from 16% in the second quarter of 2011 (decreased to 2% from 9% on a GAAP basis) due primarily to lower than planned operating expenses and improved services margins. On a GAAP basis, these improvements in operating margin were offset by $21 million of restructuring charges described below. Non-GAAP earnings per share in the second quarter of 2012 increased 15% to $0.30 from $0.26 in the second quarter of 2011 as a result of higher comparable revenue and profitability. On a GAAP basis, earnings per share in the second quarter of 2012 was $0.03 compared to $0.16 in the second quarter of 2011, reflecting the impact of the restructuring charges. Non-GAAP measures are reconciled to GAAP results under Results of Operations - Income and Margins; Earnings per Share below.

We ended the second quarter of 2012 with $224 million of cash, up from $187 million at the end of the first quarter of 2012 and $168 million at September 30, 2011, reflecting strong operating cash flow, $40 million used to repay our revolving credit facility and $15 million used for stock repurchases. We also have $140 million available under our revolving credit facility.

As part of our strategy to reduce costs and to realign our business, in the second quarter of 2012, we implemented a restructuring of our business and recorded restructuring charges of $21 million, primarily for severance and related costs associated with 168 employees (representing approximately 3% of our workforce) notified of termination during the quarter. We expect that these reductions will result in future operating expense savings of approximately $5 million per quarter. We realized approximately half of these operating expense savings in the second quarter of 2012. Cash expenditures of the restructuring charge are expected to be paid within the next twelve months, $9 million of which was paid in the second quarter.
 
We expect the near-term cost savings from this restructuring and the longer-term benefit of our organizational realignment will improve efficiencies within our sales and services organizations and improve our operating margins over the long term. 
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 providing operating income, operating margin, and diluted earnings per share as calculated under generally accepted accounting principles (“GAAP”), we also show non-GAAP operating income, operating margin, and diluted earnings per share for the reported periods. These non-GAAP measures exclude a fair value adjustment related to acquired deferred maintenance revenue, stock-based compensation, amortization of acquired intangible assets expense, acquisition-related charges, restructuring charges, one-time charges included in non-operating other income (expense) and the related tax effects of the preceding items, and any one-time tax items. Excluding those expenses and one-time items provides investors another view of our operating results which 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 Results of Operations - Income and Margins; Earnings per Share below.

20


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Three Months Ended

Percent Change 2011 to 2012
 
Six Months Ended
 
Percent Change 2011 to 2012

March 31, 2012

April 2, 2011

Actual
 
Constant Currency
 
March 31, 2012
 
April 2, 2011
 
Actual
 
Constant Currency

(dollar amounts in millions, except per share data)
License revenue
$
74.8


$
74.2


1
 %
 
1
 %
 
$
163.9

 
$
149.7

 
9
 %
 
9
 %
Consulting and training service revenue
75.8


63.0


20
 %
 
21
 %
 
151.4

 
122.7

 
23
 %
 
23
 %
Maintenance revenue
150.5


132.0


14
 %
 
14
 %
 
304.1

 
263.3

 
15
 %
 
15
 %
Total service revenue
226.3

 
195.0

 
16
 %
 
16
 %
 
455.5

 
386.0

 
18
 %
 
17
 %
Total revenue
301.1


269.2


12
 %
 
12
 %
 
619.4

 
535.7

 
16
 %
 
15
 %
Cost of license
7.8

 
6.6

 
19
 %
 
 
 
15.5

 
12.5

 
24
 %
 
 
Cost of service
85.4

 
75.2

 
14
 %
 
 
 
175.9

 
155.3

 
13
 %
 
 
Total cost of revenue
93.2

 
81.8

 
14
 %
 
 
 
191.4

 
167.8

 
14
 %
 
 
Gross margin
207.9

 
187.4

 
11
 %
 
 
 
428.0

 
367.9

 
16
 %
 
 
Operating expenses
201.0

 
163.2

 
23
 %
 
 
 
388.6

 
326.6

 
19
 %
 
 
Total costs and expenses (1)
294.2


245.0


20
 %
 
21
 %
 
580.0

 
494.4

 
17
 %
 
17
 %
Operating income (1)
$
6.9


$
24.2


(72
)%
 
(76
)%
 
$
39.4

 
$
41.3

 
(5
)%
 
(11
)%
Non-GAAP operating income (1)
$
50.6


$
42.3


20
 %
 
18
 %
 
$
109.4

 
$
77.7

 
41
 %
 
38
 %
Operating margin (1)
2
%

9
%


 

 
6
%
 
8
%
 
 
 
 
Non-GAAP operating margin (1)
17
%

16
%


 

 
18
%
 
15
%
 
 
 
 
Diluted earnings per share
$
0.03


$
0.16



 

 
$
0.21

 
$
0.27

 
 
 
 
Non-GAAP diluted earnings per share
$
0.30


$
0.26



 

 
$
0.65

 
$
0.48

 
 
 
 
Cash flow from operations (2)
$
96.5


$
78.3



 

 
$
133.0

 
$
30.2

 
 
 
 






 

 
 
 

 
 
 
 
(1) Costs and expenses in the second quarter of 2012 included $21 million of restructuring charges. In the first quarter of 2011, we entered into a strategic contract with an automotive customer for which we expected costs to exceed revenue by approximately $5 million. This loss was recorded in the first quarter of 2011 and resulted in a decrease in GAAP and non-GAAP operating income of approximately $5 million.
(2) In the first six months of 2011, we used $48 million, net, of cash in connection with the resolution of a litigation matter.

In the second quarter of 2012, compared to the second quarter of 2011, our total revenue was up 12%, reflecting revenue contribution from MKS and 4CS as well as the growth of our maintenance and services business. We acquired MKS Inc. on May 31, 2011 and 4C Solutions, Inc. on September 2, 2011. MKS and 4CS contributed $22.3 million and $40.7 million of revenue in the second quarter and first six months of 2012, respectively ($23.0 million and $43.0 million, respectively, on a non-GAAP basis). In the second quarter of 2012 organic revenue, excluding the impact of MKS and 4CS, increased 4% to $278.9 million while organic license revenue decreased 10% to $66.6 million compared to the second quarter of 2011. For the first six months of 2012 total revenue was up 8% on an organic basis compared to the first six months of 2011.

Our license revenue in the second quarter of 2012 was lower than expected due to a large transaction in Europe that did not close and lower than expected license revenue in North America. For the six months ended March 31, 2012, license revenue grew 1% on an organic basis. In the second quarter and first six months of 2012 compared to the second quarter and first six months of 2011, maintenance revenue was up 7% and 9%, respectively, on an organic basis and consulting and training service revenue was up 12% and 15%, respectively, on an organic basis. We have seen continued strength in maintenance and consulting services following strong license sales in both 2011 and 2010.
In the second quarter of 2012, license revenue from direct customers was down 7% year over year (19% on an organic basis), attributable to a decrease in the amount of revenue from large customers. We saw continued overall strength in the small- and medium-size business market in the second quarter of 2012, compared to the second quarter of 2011, with indirect license revenue and total indirect revenue up 18% and 13%, respectively (9% and 7% on an organic basis, respectively). This was our ninth consecutive quarter of year-over-year indirect license revenue and total indirect revenue growth. In the first six months of 2012, license revenue and total revenue from direct customers were up 8% and 17%, respectively, year over year

21


(down 1% and up 9%, respectively, on an organic basis). In the first six months of 2012, license revenue and total revenue from indirect customers was up 13% and 12%, respectively, year over year (up 6% and 7%, respectively, on an organic basis).
Our GAAP and non-GAAP operating income improved due to higher margins, particularly in our services business, coupled with slower growth in operating expenses.
Future Expectations, Strategies and Risks

Based on the the first six months of 2012 and fiscal 2011 results, current economic conditions and spending patterns, the competitive strength of our products, additional sales capacity and a full year of revenue contribution from MKS, for fiscal year 2012 we are currently targeting non-GAAP and GAAP revenue growth of 8% to 10%. This reflects a decrease in our full year targets for 2012 from those projected at the end of the first quarter of 2012, reflecting lower than expected license revenue in the second quarter of 2012. Changes in foreign currency rates relative to the U.S. dollar can significantly impact our results. Our current plan assumes $1.30 USD to Euro rate. We expect MKS and 4CS to contribute approximately $90 million in revenue for the full year, including $3 million in non-GAAP revenue. For 2012, compared to 2011, we are expecting license revenue growth of approximately 5%, non-GAAP and GAAP maintenance revenue growth of approximately 9%, and consulting and training service revenue growth of approximately 14%.

Our commitment to operating margin expansion is a cornerstone of our financial strategy, which is reflected in our margin performance in the first six months of 2012 and our outlook for 2012 and beyond. Our goal is to improve non-GAAP operating margins by 130 basis points in 2012, from approximately 18% in 2011 to approximately 19% in 2012 (compared to approximately 10% on a GAAP basis), through operating leverage, impact of the restructuring, our on-going focus on operating margin improvements and cost efficiency, and improved services margins in our consulting and training services business. Our expectation for services revenue growth has increased due to continued momentum of our Enterprise solutions and demand for associated services. We are also anticipating that services margins will increase for the year due to increased revenue and expanded use of our strategic services partners.
We acknowledge that there continues to be significant uncertainty regarding the strength of the global economy. While we are continuing to add sales capacity to address our expanded market opportunities, at the same time we continue to be disciplined about broader staffing and spending plans.
Our results have been impacted, and we expect will continue to be impacted, by revenue from large customers. 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 Enterprise solutions among 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 increased volatility in our results.
Impact of an Investigation in China
As previously disclosed, we have undertaken an investigation of payments by certain business partners and expenses by certain employees in China that raise questions of compliance with laws, including the Foreign Corrupt Practices Act, and/or compliance with our business policies. The termination of certain employees and business partners in China in connection with this matter may have an adverse impact on our level of sales in China until replacements for those employees and business partners are in place and productive. Revenue from China has historically represented 6% to 7% of our total revenue. We have voluntarily disclosed the results of our investigation and associated remedial actions to the United States Department of Justice and the Securities and Exchange Commission and are cooperating to provide additional information as requested. We are unable to predict the outcome of this matter, which could include fines or other sanctions.

Results of Operations
Acquisitions
We acquired MKS on May 31, 2011 and 4C Solutions, Inc. (4CS) on September 2, 2011. The results of operations of these acquired businesses have been included in our consolidated financial statements beginning on their respective acquisition dates. These acquisitions added $22.3 million and $40.7 million to our revenue for the three and six months ended March 31, 2012, respectively ($23.0 million and $43.0 million on a non-GAAP basis, respectively).
MKS revenue and 4CS revenue are classified as “Enterprise” revenue.
Impact of Foreign Currency Exchange on Results of Operations

22


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 reported results for the second quarter and first six months of 2012 had been converted into U.S. Dollars based on the foreign currency exchange rates in effect for the comparable 2011 periods, revenue would have been higher by $0.7 million and lower by $2.5 million in the second quarter and first six months of 2012, respectively, and expenses would have been higher by $1.7 million and $0.1 million, respectively. As a result, at foreign currency exchange rates consistent with the first six months of 2011, operating income in the second quarter and first six months of 2012 would have been lower by $1.0 million and $2.6 million, respectively. 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 year over year on a constant currency basis, calculated by multiplying the actual results for the second quarter and first six months of 2012 by the exchange rates in effect for the comparable periods in 2011.
Revenue
Desktop revenue includes our CAD Solutions: Creo Parametric, Creo Elements/Direct, Arbortext authoring products and Mathcad. Enterprise revenue includes our PLM solutions: Windchill, Arbortext enterprise products, Creo View, and Integrity.
Direct revenue includes sales made primarily by our direct sales force to large businesses. Indirect revenue includes sales by our reseller channel, primarily to small- and medium-size businesses, as well as revenue from other accounts that we have classified as indirect. If the classification of a customer changes between direct and indirect, we reclassify the historical revenue associated with that customer to align with the current period classification. Such reclassifications were not material in the periods presented.
Enterprise maintenance revenue in the second quarter and first six months of 2012 includes a fair value adjustment related to acquired deferred MKS maintenance revenue of $0.7 million and $2.3 million, respectively. Non-GAAP revenue excludes this adjustment. Accordingly, non-GAAP revenue, non-GAAP Enterprise revenue, non-GAAP maintenance revenue and MKS non-GAAP revenue in the previous and following discussion are higher than the corresponding GAAP revenue figures by the amount of this adjustment.

23





Revenue by Product Group and Distribution Channel - Three months ended March 31, 2012 and April 2, 2011
 
Desktop
Three Months Ended
 
Enterprise
Three Months Ended
 
Total Revenue
Three Months Ended
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
(Dollar amounts in millions)
Direct
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
20.9

 
$
31.3

 
(33
)%
 
$
27.9

 
$
20.9

 
33
%
 
$
48.7

 
$
52.2

 
(7
)%
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
7.7

 
9.5

 
(19
)%
 
63.1

 
50.6

 
25
%
 
70.8

 
60.2

 
18
 %
Maintenance
52.8

 
50.9

 
4
 %
 
42.6

 
29.7

 
44
%
 
95.4

 
80.5

 
18
 %
Total service revenue
60.5

 
60.4

 
 %
 
105.7

 
80.3

 
32
%
 
166.2

 
140.7

 
18
 %
Total revenue
$
81.4

 
$
91.6

 
(11
)%
 
$
133.5

 
$
101.2

 
32
%
 
$
214.9

 
$
192.9

 
11
 %
Indirect
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
19.0

 
$
17.8

 
7
 %
 
$
7.0

 
$
4.2

 
66
%
 
$
26.0

 
$
22.0

 
18
 %
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
1.4

1.6

1.6

 
(10
)%
 
3.6

 
1.3

 
176
%
 
5.0

 
2.9

 
74
 %
Maintenance
45.9

 
44.1

 
4
 %
 
9.2

 
7.4

 
26
%
 
55.2

 
51.4

 
7
 %
Total service revenue
47.3

 
45.7

 
4
 %
 
12.8

 
8.7

 
48
%
 
60.2

 
54.3

 
11
 %
Total revenue
$
66.4

 
$
63.4

 
5
 %
 
$
19.9

 
$
12.9

 
54
%
 
$
86.2

 
$
76.3

 
13
 %
Total Revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
39.9

 
$
49.0

 
(19
)%
 
$
34.9

 
$
25.2

 
39
%
 
$
74.8

 
$
74.2

 
1
 %
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
9.1

 
11.1

 
(17
)%
 
66.7

 
51.9

 
28
%
 
75.8

 
63.0

 
20
 %
Maintenance
98.7

 
94.9

 
4
 %
 
51.8

 
37.0

 
40
%
 
150.5

 
131.9

 
14
 %
Total service revenue
107.9

 
106.0

 
2
 %
 
118.5

 
89.0

 
33
%
 
226.3

 
195.0

 
16
 %
Total revenue
$
147.8

 
$
155.1

 
(5
)%
 
$
153.4

 
$
114.1

 
34
%
 
$
301.1

 
$
269.2

 
12
 %

24


Revenue by Product Group and Distribution Channel - Six months ended March 31, 2012 and April 2, 2011

 
Desktop
Six Months Ended
 
Enterprise
Six Months Ended
 
Total Revenue
Six Months Ended
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
March 31, 2012
 
April 2, 2011
 
Percent
Change
 
(Dollar amounts in millions)
Direct
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
44.1

 
$
55.6

 
(21
)%
 
$
69.3

 
$
49.4

 
40
%
 
$
113.3

 
$
105.0

 
8
%
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
17.0

 
18.7

 
(10
)%
 
125.2

 
98.1

 
28
%
 
142.2

 
116.9

 
22
%
Maintenance
107.5

 
101.0

 
6
 %
 
84.2

 
59.6

 
41
%
 
191.7

 
160.6

 
19
%
Total service revenue
124.5

 
119.8

 
4
 %
 
209.4

 
157.7

 
33
%
 
333.9

 
277.5

 
20
%
Total revenue
$
168.6

 
$
175.4

 
(4
)%
 
$
278.7

 
$
207.1

 
35
%
 
$
447.2

 
$
382.4

 
17
%
Indirect
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
36.7

 
$
34.7

 
6
 %
 
$
13.8

 
$
10.0

 
38
%
 
$
50.6

 
$
44.7

 
13
%
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
2.8

 
2.9

 
(3
)%
 
6.5

 
3.0

 
117
%
 
9.3

 
5.9

 
58
%
Maintenance
93.6

 
88.4

 
6
 %
 
18.8

 
14.3

 
31
%
 
112.4

 
102.7

 
9
%
Total service revenue
96.3

 
91.3

 
6
 %
 
25.3

 
17.3

 
46
%
 
121.6

 
108.6

 
12
%
Total revenue
$
133.1

 
$
126.0

 
6
 %
 
$
39.1

 
$
27.3

 
43
%
 
$
172.2

 
$
153.3

 
12
%
Total Revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
License revenue
$
80.8

 
$
90.3

 
(10
)%
 
$
83.1

 
$
59.4

 
40
%
 
$
163.9

 
$
149.7

 
9
%
Service revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consulting and training
19.7

 
21.6

 
(9
)%
 
131.7

 
101.1

 
30
%
 
151.4

 
122.7

 
23
%
Maintenance