PTC INC. - Annual Report: 2022 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the Fiscal Year Ended: September 30, 2022

OR

For the transition period from_ to_

Commission File Number: 0-18059

PTC Inc.

(Exact name of registrant as specified in its charter)

121 Seaport Boulevard, Boston, MA 02210

(Address of principal executive offices, including zip code)

(781) 370-5000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant

to Section 12(g) of the Act: None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☑ No ☐

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☑

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 ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☑ 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.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☑

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑

The aggregate market value of our voting stock held by non-affiliates was approximately $11,336,087,091 on March 31, 2022 based on the last reported sale price of our common stock on the Nasdaq Global Select Market on that date. There were 116,975,644 shares of our common stock outstanding on that day and 117,471,969 shares of our common stock outstanding on November 14, 2022.

DOCUMENTS INCORPORATED BY REFERENCE

PTC Inc.

ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR 2022

Table of Contents

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Cautionary Note About Forward-Looking Statements

This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. In particular, statements that are not historical facts, including but not limited to, statements about our anticipated financial results, capital development and growth, as well as about the development of our products, markets and workforce, are forward-looking statements. These forward-looking statements are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions, whether in the negative or affirmative. Forward-looking statements are based on our current plans, expectations and assumptions and are not guarantees of future performance. Factors that may cause our actual results to differ materially from these statements include, but are not limited to, the risks and uncertainties discussed in Item 1A. “Risk Factors” and elsewhere throughout this Annual Report. Such factors, among others, could have a material adverse effect upon our business, results of operations and financial condition. We caution readers not to place undue reliance on any forward-looking statements, which only speak as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

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

PART I

ITEM 1. Business

Our Business

PTC is a global software company that provides a portfolio of innovative digital solutions that work together to transform how physical products are engineered, manufactured, and serviced.

Our software portfolio includes award-winning offerings in the computer-aided design (CAD) and product lifecycle management (PLM) markets. CAD is utilized for product data authoring and PLM is for product data management and process orchestration. Our software can be delivered on premises, in the cloud, or in a hybrid model.

Our customer base includes some of the world's most innovative manufacturers in the aerospace and defense, automotive, electronics and high tech, industrial machinery and equipment, life sciences, retail and consumer products industries.

We generate revenue through the sale of software subscriptions, which include license access and support (technical support and software updates); support for perpetual licenses; cloud services (hosting for our software and software-as-a-service (SaaS)); perpetual licenses; and professional services (consulting, implementation, and training).

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Our Strategy

There are three key elements to our strategy to deliver long-term shareholder value.

Accelerate Digital Thread Solutions

With our solutions, we enable companies to adopt a “digital thread” strategy to drive innovation and productivity. A digital thread manages product data and makes it accessible and useful to the right people, at the right time, and in the right context. This is particularly relevant for larger businesses pursuing a vertically integrated manufacturing strategy in which the reuse and repurposing of earlier innovations drives next generation product offerings.

Accelerate Product Innovation

We enable companies to upend the product development process with solutions that apply agile concepts, originally focused on software development, to the entire product innovation process, from software to hardware and electronics. By applying agile product development processes across all three disciplines, companies can increase innovation velocity and bring new products to market faster to meet rapidly changing market demand. This is particularly relevant for start-up and upstart businesses focused on technology-centered innovations that commonly leverage contract manufacturers for production of their designs.

Accelerate SaaS Transformation

Manufacturers today face a myriad of business challenges. Macroeconomic forces, such as an ever-evolving workforce, supply chain disruptions, the rise of smart, connected products, and the need to prove sustainability, are all driving the need for change. We enable companies to respond to these challenges with technology that leverages the cloud to transform how, where, and when work gets done. Software-as-a-service (SaaS), which has already reshaped nearly all aspects of business, is poised to transform management of the entire product lifecycle. Anticipating this need, PTC acquired the Onshape and Arena cloud-native product development solutions. In parallel, we are heavily investing to transform our technology portfolio to SaaS.

Strategic Transactions

During FY'22, we completed two strategic transactions. In Q3'22, we acquired the CodebeamerTM application lifecycle management business to broaden and deepen our ALM footprint across safety-critical and regulated industries. In Q3'22, we also sold a portion of our PLM services business to ITC Infotech. The transaction is designed to accelerate customer digital transformation initiatives and adoption of our Windchill+ SaaS solution. Refer to Note 6. Acquisitions and Disposition of Business of Notes to Consolidated Financial Statements in this Annual Report for additional discussion regarding these transactions.

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Our Principal Products and Services

In 2022, we reported our business in two product groups: Digital Thread and Velocity. Digital Thread included products focused on customers that are embracing enterprise-wide digital transformation and Velocity included products focused on customers that prioritize agile product development. Beginning in fiscal year 2023, we are reporting our businesses in two new product groups: CAD (Computer-Aided Design) and PLM (Product Lifecycle Management). Products designated as CAD refer to software used for product data authoring. Products designated as PLM refer to software used for product data management and process orchestration.

The new reporting structure aligns better to our strategy, product offerings and industry segments.

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To meet the increasing demand for SaaS delivered solutions, we expect to introduce a number of new SaaS offerings over time. These service offerings will provide an alternative to our traditional on-premises software products and provide our customers with the benefits of SaaS including accelerated time to value, reduced complexity, lower costs to implement, upgrade and administer, improved user collaboration and mobility, and scalability. We are giving this new generation of offerings a “plus” brand. We launched Windchill+ in the second quarter of 2022.

Our Markets and How We Address Them

The markets we serve present different growth opportunities for us. We see opportunity for further market growth for all our solutions with a new generation of SaaS solutions we are developing to bring to market over the next few years.

We derive most of our sales from products and services sold directly by our sales force to end-user customers. Approximately 25% to 30% of our sales of products and services are through third-party resellers. Our sales force focuses on large accounts, while our reseller channel provides a cost-effective means of covering the small- and medium-size business market. Our strategic alliance partners enable us to increase our market reach, offer broader solutions, and add compelling technology to our offerings. Our strategic services partners provide service offerings to help customers implement our product offerings and transition to SaaS.

Additional financial information about our segments and international and domestic operations may be found in Note 18. Segment and Geographic Information of Notes to Consolidated Financial Statements in this Annual Report, which information is incorporated herein by reference.

Competition

We compete with a number of companies whose offerings address one or more specific functional areas covered by our solutions. For enterprise Creo and Windchill solutions, we compete with large established companies including Autodesk, Dassault Systèmes SA, and Siemens AG. In our IIoT business, we compete with large established companies such as Amazon, IBM, Oracle, SAP, Siemens AG, and Software AG as well as customers’ homegrown solutions. There are also a number of smaller companies that compete in the market for IIoT products. For our AR products, our primary competitors include Microsoft, TeamViewer, and ScopeAR. For our ALM products, we compete with IBM and Siemens AG. For our SLM products, we compete with companies that offer point solutions and with customers’ homegrown solutions.

Proprietary Rights

Our software products and related technical know-how, along with our trademarks, including our company names, product names and logos, are proprietary. We protect our intellectual property rights in these items by relying on copyrights, trademarks, patents and common law safeguards, including trade secret protection. The nature and extent of such legal protection depends in part on the type of intellectual property right and the relevant jurisdiction. In the U.S., we are generally able to maintain our trademark registrations for as long as the trademarks are in use and to maintain our patents for up to 20 years from the earliest effective filing date. We also use license management and other anti-piracy technology measures, as well as contractual restrictions, to curtail the unauthorized use and distribution of our products.

Our proprietary rights are subject to the risks and uncertainties described under Item 1A. “Risk Factors” below, which is incorporated into this section by reference.

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People and Culture

PTC’s commitment to building a diverse, equitable, and inclusive culture is fundamental to our purpose – the Power to Create – and critical to every aspect of our talent strategy. Our approach is focused on sustainable talent practices and core values that promote an agile culture, an increased sense of belonging, engaged work environments, and high-performing teams.

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PTC at-a-Glance

As of September 30, 2022, PTC had 6,503 full-time employees. Our employee population is geographically diverse and serves a geographically diverse customer and partner network.

Worldwide Employee Representation

United States Employee Representation

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Compensation and Benefits

PTC provides a comprehensive and competitive compensation and benefits package designed to attract, retain, motivate, and engage talent around the world that will drive success and innovation in meeting the goals of our business.

We provide employees with competitive base salaries, incentive compensation and, in many cases, equity compensation.

Our benefits offerings are designed to meet the unique needs of our employees. We believe we provide competitive benefits in each local market we operate in to help our employees care for themselves and their families. Common offerings are health benefits, retirement benefits, life insurance and disability protection, employee assistance, vacation time, holidays and leave benefits. To ensure our employees and families have the support they need as the COVID-19 pandemic begins to ease, PTC has continued its global emergency leave policy, which provides for ten days of paid time off over and above regular sick or other time off to recuperate from or care for a family member recovering from COVID-19.

Employee Development

We invest in our employees, creating meaningful opportunities to learn, grow, develop and advance their careers. We have specific development programs, including our Rotational Leadership Development, Managing at PTC, Leading at PTC, and 360-degree development programs.

Commitment to Diversity, Equity, and Inclusion (DEI)

We are improving our systems and processes to enable us to better track, manage and develop our employees. With these improvements, we are gaining a better understanding of our current demographic population and developing demographic goals, as we strive to create a more demographically diverse, inclusive, and equitable organization.

Starting in FY’22, our Self-Identification program invited U.S. employees to volunteer their personal information across categories such as race/ethnicity, sexual orientation, gender identity, pronouns, disability, veteran and military status, and more. By analyzing this information in aggregate, we can determine what we should adjust in terms of DEI programming, policies, and hiring practices.

Commitment to our values and diversity in our workforce has inspired our top-line company goals. Key milestones include launching leadership development experiences for underrepresented minority and underrepresented group populations, offering learning programs in psychological safety, requiring unconscious bias training for hiring managers, and enhancing our Employee Resource Group (ERG) program and Global DEI Champions Network. PTC currently supports 12 ERGs that span a broad spectrum of identities, experiences, and interests: Asian, Black, Early Career, Energize (Health & Wellness), Family, Green (Sustainability), Hola (Hispanic & Latine), Prism (LGBTQ+), SMART (Neurodiversity), Veterans, Virtual, and Women. In 2021, we introduced a CEO Rotation program that allows our CEO to spend three months with each ERG as a rotational sponsor.

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Additional Information About Our Employee Initiatives

You can find more information about our employee initiatives, including our DEI, Training and Career Development, Compensation & Benefits, Employee Engagement, and Employee Health & Safety initiatives, in our Corporate Social Responsibility Report available on PTC.com. The references to our Corporate Social Responsibility Report and our website are not intended to incorporate information in that report or on our website into this Annual Report by reference.

Available Information

We make available free of charge on our website at www.ptc.com the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the SEC: our Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; our Current Reports on Form 8-K; and amendments to those reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934. Our Proxy Statements for our Annual Meetings and Section 16 trading reports on SEC Forms 3, 4 and 5 also are available on our website. The reference to our website is not intended to incorporate information on our website into this Annual Report by reference.

Corporate Information

PTC was incorporated in Massachusetts in 1985 and is headquartered in Boston, Massachusetts.

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ITEM 1A. Risk Factors

The following are important factors we have identified that could affect an investment in our securities. You should consider them carefully when evaluating an investment in PTC securities, because these factors could cause actual results to differ materially from historical results or any forward-looking statements. The risks described below are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and/or operating results.

I. Risks Related to Our Business Operations and Industry

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

The markets for our products and solutions are rapidly changing and characterized by intense competition, disruptive technology developments, evolving distribution models and increasingly lower barriers to entry. If we are unable to provide products and solutions that address customers’ needs as well as our competitors’ products and solutions do, or to align our pricing, licensing and delivery models with customer preferences, we could lose customers and/or fail to attract new customers, which could cause us to lose revenue and market share.

For example, the COVID-19 pandemic caused companies worldwide to close their offices and their employees to have to work remotely from their homes, and there remains uncertainty about the extent to which employees will return to the office in the long term. This has focused companies on the need for solutions that empower and support remote work by employees. We believe customers and potential customers will increasingly seek software solutions that support remote work by employees. Although many of our solutions support remote work, others are less efficient at doing so. We have embarked on an effort to make our solutions available on a SaaS platform; however, this will require significant effort and investment and we cannot be sure that we will be able to make our solutions available as SaaS solutions as quickly as we expect or that customers will adopt them as we expect. If we are unable to compete successfully with competitors offering SaaS solutions, we could lose customers and/or fail to attract new customers, which could cause us to lose revenue and market share, which would adversely affect our business and financial results.

In addition, competitive pressures could cause us to reduce our prices, which could reduce our revenue and margins.

Our current and potential competitors range from large and well-established companies to emerging start-ups. Some of our competitors and potential competitors have greater name recognition in the markets we serve and greater financial, technical, sales and marketing, and other resources, which could limit our ability to gain customer recognition and confidence in our products and solutions and successfully sell our products and solutions, which could adversely affect our ability to grow our business.

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

We have implemented and continue to implement measures intended to maintain the security and integrity of our products, source code and IT systems. The potential for a security breach or system disruption has significantly increased over time as the scope, number, intensity and sophistication of attempted cyberattacks and cyber intrusions have increased – particularly cyberattacks and intrusions designed to access and exfiltrate information and to disrupt and lock-up access to systems for the purpose of demanding a ransom payment. It is impossible for us to eliminate the risk of a successful cyberattack or intrusion, and, in fact, we deal with security issues on a regular basis and have experienced security incidents from time to time. Accordingly, there is a risk that a cyberattack or intrusion will be successful and that such event will be material.

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In addition, we offer cloud services to our customers and some of our products, including our SaaS products, are hosted by third-party service providers, which expose us to additional risks as those repositories of our customers’ proprietary data may be targeted and a cyberattack or intrusion may be successful and material. Interception of data transmission, misappropriation or modification of data, corruption of data and attacks against our service providers may adversely affect our products or product and service delivery. Malicious code, viruses or vulnerabilities that are undetected by our service providers may disrupt our business operations generally and may have a disproportionate effect on those of our products that are developed and delivered in the cloud environment.

While we devote resources to maintaining the security and integrity of our products and systems, as well as performing due diligence of our third-party service providers, security breaches that have not had a material effect on our business or that of our customers have occurred, and we will continue to face cybersecurity threats and exposure. A significant breach of the security and/or integrity of our products or systems, or those of our third-party service providers, whether or intentional or by human error by our employees or others, could disrupt our business operations or those of our customers, could prevent our products from functioning properly, could enable access to sensitive, proprietary or confidential information of our customers, or could enable access to our sensitive, proprietary or confidential information. This could require us to incur significant costs of investigation, remediation and/or payment of a ransom; harm our reputation; cause customers to stop buying our products; and cause us to face lawsuits and potential liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

We increasingly rely on third-party providers of cloud infrastructure services to deliver our offerings to users on our platform, and any disruption of or interference with our use of these services could adversely affect our business.

Our continued growth depends in part on the ability of our existing and potential customers to use and access our cloud services or our website in order to download our software or encrypted access keys for our software within an acceptable amount of time. We use a number of third-party service providers that we do not control for key components of our infrastructure, particularly with respect to development and delivery of our cloud-based products. The use of these service providers gives us greater flexibility in efficiently delivering a more tailored, scalable customer experience, but also exposes us to additional risks and vulnerabilities. Third-party service providers operate their own platforms that we access, and we are, therefore, vulnerable to their service interruptions. We may experience interruptions, delays and outages in service and availability from time to time as a result of problems with our third-party service providers’ infrastructure. Lack of availability of this infrastructure could be due to a number of potential causes including technical failures, natural disasters, fraud or security attacks that we cannot predict or prevent. Such outages could trigger our service level agreements with customers and require us to issue the issuance of credits to our cloud-based product customers, which could adversely impact our business, financial condition and results of operations.

If we are unable to renew our agreements with our cloud service providers on commercially reasonable terms, or any of our agreements are prematurely terminated, or we need to add new cloud services providers to increase capacity and uptime, we could experience interruptions, downtime, delays, and additional expenses related to transferring to and providing support for these new platforms. Any of the above circumstances or events may harm our reputation and brand, reduce the availability or usage of our platforms and impair our ability to attract new users, any of which could adversely affect our business, financial condition and results of operations.

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We may be unable to hire or retain personnel with the necessary skills to operate and grow our business, which could adversely affect our ability to compete.

Our success depends upon our ability to attract and retain highly skilled managerial, sales and marketing, technical, financial and administrative personnel to operate and grow our business. Competition for such personnel in our industry is intense, particularly in the Boston, Massachusetts area where our global headquarters is located.

The technical personnel required to develop our products and solutions are in high demand. If we are unable to attract and retain technical personnel with the requisite skills, our product and solution development efforts could be delayed, which could adversely affect our ability to compete and thereby adversely affect our revenues and profitability.

The managerial, sales and marketing, financial and administrative personnel necessary to guide our operations, market and sell our solutions and support our business operations are also in high demand due to intense competition in our industry.

If we are unable to attract and retain the personnel we need to develop compelling products and solutions, and guide, operate and support our business, we may be unable to successfully compete, which would adversely affect our business, financial condition and results of operations.

We depend on sales within the discrete manufacturing sector and our business could be adversely affected if manufacturing activity does not grow, or if it contracts, or if manufacturers are adversely affected by other macroeconomic factors.

A large amount of our sales are to customers in the discrete manufacturing sector. Manufacturers worldwide continue to face uncertainty about the global macroeconomic environment due to, among other factors, the effects of earlier and ongoing supply chain disruptions, rising interest rates and inflation, volatile foreign exchange rates and the current relative strength of the U.S. dollar, the effects of the Russia—Ukraine conflict, including on the supply of energy resources in Europe, and the U.S. Government’s focus on technology transactions with non-U.S. entities. In light of these challenges and concerns, customers may delay, reduce, or forego purchases of our solutions, which would adversely affect our business and financial results.

If we fail to successfully manage our transition to a SaaS company, our business and financial results could be adversely affected.

Becoming a SaaS company requires considerable additional investment in our organization. Whether our transition will be successful and will accomplish our business and financial objectives is subject to uncertainties, including but not limited to: customer demand, attach and renewal rates, channel adoption, our ability to further develop and scale infrastructure, our ability to include functionality and usability in such offerings that address customer requirements, and our costs. If we are unable to successfully establish these new offerings and navigate our business transition due to these risks and uncertainties, our business and financial results could be adversely impacted.

Because our sales and operations are globally dispersed, we face additional compliance risks and any compliance failure could adversely affect our business and financial results.

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

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Those laws include, but are not limited to, anti-corruption laws and regulations (including the U.S. Foreign Corrupt Practices Act (FCPA) and the U.K. Bribery Act 2010), data privacy laws and regulations (including the European Union's General Data Privacy Regulation), and trade and economic sanctions laws and regulations (including laws administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control, the U.S. State Department, the U.S. Department of Commerce, the United Nations Security Council and other relevant sanctions authorities). Our compliance risks are heightened due to the go-to-market approach for our business that relies heavily on a partner ecosystem, the fact that we operate in countries with a higher incidence of corruption and fraudulent business practices than others, the fact that we deal with governments and state-owned business enterprises, and the fact that global enforcement of laws has significantly increased.

Accordingly, while we strive to maintain a comprehensive compliance program, an employee, agent or business partner may violate our policies or U.S. or other applicable laws or we may inadvertently violate such laws. Investigations of alleged violations of those laws can be expensive and disruptive. Violations of such laws can lead to civil and/or criminal prosecutions, substantial fines and other sanctions, including the revocation of our rights to continue certain operations, and also cause business loss and reputational harm, which could adversely affect our financial results and/or stock price.

II. Risks Related to Acquisitions and Strategic Relationships

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

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

The types of issues that we may face in integrating and operating the acquired business include:

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Further, if we do not achieve the expected return on our investments, it could impair the intangible assets and goodwill that we recorded as part of an acquisition, which could require us to record a reduction to the value of those assets.

We may incur significant debt or issue a material amount of debt or equity securities to finance an acquisition, which could adversely affect our operating flexibility and financial statements.

If we were to incur a significant amount of debt—whether by borrowing funds under our credit facility or otherwise or issuing new debt securities—to finance an acquisition, our interest expense, debt service requirements and leverage would increase significantly. The increases in these expenses and in our leverage could constrain our ability to operate as we might otherwise or to borrow additional amounts.

If we were to issue a significant amount of equity securities in connection with an acquisition, existing stockholders would be diluted and earnings per share could decrease.

Our inability to maintain or develop our strategic and technology relationships could adversely affect our business.

We have many strategic and technology relationships with other companies with which we work to offer complementary solutions and services, that market and sell our solutions and that provide technologies that we embed in our solutions. We may not realize the expected benefits from these relationships and such relationships may be terminated by the other party. If these companies fail to perform or if a company terminates or substantially alters the terms of the relationship, we could suffer delays in product development, reduced sales or other operational difficulties and our business, results of operations and financial condition could be materially adversely affected.

III. Risks Related to Our Intellectual Property

We may be unable to adequately protect our proprietary rights, which could adversely affect our business and our ability to compete effectively.

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

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

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

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

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IV. Risks Related to Our Indebtedness

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

We have a significant amount of indebtedness. As of November 15, 2022, our total debt outstanding was approximately $1,359 billion, $1 billion of which was associated with the 3.625% Senior Notes and 4.000% Senior Notes (together, “Senior Notes”) issued in February 2020, which mature in February 2025 and 2028, respectively, and are unsecured, and $359 million of which was borrowed under our credit facility, which matures in February 2025. All amounts outstanding under the credit facility and the Senior Notes will be due and payable in full on their respective maturity dates. As of November 15, 2022, we had unused commitments under our credit facility of $641 million. PTC Inc. and one of our foreign subsidiaries are eligible borrowers under the credit facility and certain other foreign subsidiaries may become borrowers under our credit facility in the future, subject to certain conditions.

Specifically, our level of debt could:

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

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

We and our subsidiaries may be able to incur significant additional indebtedness and other obligations in the future, including secured debt. Although the credit agreement governing our credit facility contains restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions. The additional indebtedness incurred in compliance with these restrictions could be substantial. In addition, the credit agreement and the indenture governing our Senior Notes due 2025 and 2028, will not prevent us from incurring obligations that do not constitute indebtedness. If new debt is added to our current debt levels, or we incur other obligations, the related risks that we now face could intensify.

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

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

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

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

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

We are required to comply with certain financial and operating covenants under our debt agreements. Any failure to comply with those covenants could cause amounts borrowed to become immediately due and payable and/or prevent us from borrowing under the credit facility.

We are required to comply with specified financial and operating covenants under our debt agreements and to make payments under our debt, which limit our ability to operate our business as we otherwise might operate it. Our failure to comply with any of these covenants or to meet any debt payment obligations could result in an event of default which, if not cured or waived, would result in any amounts outstanding, including any accrued interest and/or unpaid fees, becoming immediately due and payable. We might not have enough working capital or liquidity to satisfy any repayment obligations if those obligations were accelerated. In addition, if we are not in compliance with the financial and operating covenants under the credit facility when we wish to borrow funds, we will be unable to borrow funds.

In addition, the financial and operating covenants under the credit facility may limit our ability to borrow funds, including for strategic acquisitions and share repurchases.

Our credit facility has variable interest tied to LIBOR and we could become subject to higher interest rates if the replacement rate we agree on with our banks is higher.

Borrowings under our revolving credit facility use the London Interbank Offering Rate (LIBOR) as a benchmark for establishing the interest rate. On March 5, 2021, the Intercontinental Exchange Benchmark Administration, the U.K. Financial Conduct Authority (FCA) regulated and authorized administrator of LIBOR, announced, and the FCA confirmed, that one week and two-month USD LIBOR settings will cease on December 31, 2021, and that the USD LIBOR panel for all other tenors will cease on June 30, 2023.

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The credit facility provides a mechanism pursuant to which we and the administrative agent may agree, under certain circumstances, to transition to an alternate base rate borrowing or amend the credit facility to establish an alternate interest rate to LIBOR that includes consideration of the then-prevailing market convention for determining interest rates for syndicated loans in the United States at that time.

Although we believe the alternative rates will not materially increase the rates on our credit facility, the final agreed rate may increase the cost of our variable rate indebtedness.

V. Risks Related to Our Common Stock

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

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

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

Our stock price has been volatile, which may make it harder to resell shares at a favorable time and price.

Market prices for securities of software companies are generally volatile and are subject to significant fluctuations that may be unrelated or disproportionate to the operating performance of these companies. Further, our stock price has been more volatile than that of other software companies. Accordingly, the trading prices and valuations of software companies’ stocks, and of ours, may not be predictable. Negative changes in the public’s perception of the prospects of software companies, or of PTC or the markets we serve, could depress our stock price regardless of our operating results.

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Also, a large percentage of our common stock is held by institutional investors and by Rockwell Automation. Purchases and sales of our common stock by these investors could have a significant impact on the market price of the stock.

VI. General Risk Factors

Our international businesses present economic and operating risks, which could adversely affect our business and financial results.

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

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

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

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

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

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ITEM 1B. Unresolved Staff Comments

None.

ITEM 2. Properties

We currently have 98 office locations used in operations in the United States and internationally, predominately as sales and/or support offices and for research and development work. Of our total of approximately 1,209,000 square feet of leased facilities used in operations, approximately 484,000 square feet are located in the U.S., including 250,000 square feet at our headquarters facility located in Boston, Massachusetts, and approximately 250,000 square feet are located in India, where a significant amount of our research and development is conducted.

ITEM 3. Legal Proceedings

Information on legal proceedings can be found in Note 10. Commitments and Contingencies -- Legal Proceedings of Notes to Consolidated Financial Statements in this Annual Report, which information is incorporated herein by reference.

ITEM 4. Mine Safety Disclosures

Not applicable.

PART II

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the Nasdaq Global Select Market under the symbol "PTC."

On September 30, 2022, the close of our fiscal year, and on November 14, 2022, our common stock was held by 1,003 and 1,000 shareholders of record, respectively.

ITEM 6. [Reserved]

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Annual Report about anticipated financial results, capital developments and growth, as well as about the development of our products, markets and workforce, are forward-looking statements that are based on our current plans and assumptions. Important information about the bases for these plans and assumptions and factors that may cause our actual results to differ materially from these statements is contained below and in Item 1A. “Risk Factors” of this Annual Report.

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

Operating and Non-GAAP Financial Measures

Our discussion of results includes discussion of our ARR (Annual Run Rate) operating measure, non-GAAP financial measures, and disclosure of our results on a constant currency basis. ARR and our non-GAAP financial measures, including the reasons we use those measures, are described below in Results of Operations - Operating Measure and Results of Operations - Non-GAAP Financial Measures, respectively. The methodology used to calculate constant currency disclosures is described in Results of Operations - Impact of Foreign Currency Exchange on Results of Operations. You should read those sections to understand our operating measure, non-GAAP financial measures, and constant currency disclosures.

Executive Overview

ARR increased 7% (16% constant currency) to $1,572 million in FY’22 compared to the end of FY’21. Excluding the impact of Codebeamer, which we acquired in the third quarter of FY’22, organic ARR growth was 6% (15% constant currency) in FY’22 compared to FY’21.

FY’22 revenue of $1.93 billion increased 7% over FY’21 (11% in constant currency). FY’22 operating margin of 23% increased approximately 200 basis points over FY’21 and non-GAAP operating margin of 38% increased approximately 300 basis points. Operating margin improvements are due to higher revenue and continued operating expense discipline. FY’22 diluted EPS was $2.65 compared to $4.03 in FY'21. Diluted EPS in FY'22 included a $35 million non-operating charge associated with the decrease in value of an equity investment in a publicly-traded company, offset by a non-operating $30 million credit associated with the sale of a portion of our PLM services business. Diluted EPS in FY'21 benefited from gains associated with an equity investment in a publicly-traded company, and income tax credits related to a release of a previously held valuation allowance. FY'22 non-GAAP diluted EPS was $4.58, representing a 15% increase over non-GAAP diluted EPS of $3.97 in FY'21.

FY’22 operating cash flow of $435 million grew 18% over FY’21; FY’22 free cash flow of $416 million grew 21% over FY’21. FY'22 operating cash flow and free cash flow included an $11.8 million outflow related to acquisition and transaction-related costs and $40.8 million of restructuring payments. We ended FY’22 with cash and cash equivalents of $272 million and gross debt of $1.36 billion, with an aggregate interest rate of 3.9%.

Results of Operations

The following table shows the measures that we consider the most significant indicators of our business performance. In addition to providing operating income, operating margin, diluted earnings per share and cash from operations as calculated under GAAP, we provide our ARR operating measure and non-GAAP operating income, non-GAAP operating margin, non-GAAP diluted earnings per share, and free cash flow for the reported periods. We also provide a view of our actual results on a constant currency basis. Our non-GAAP financial measures exclude the items described in Non-GAAP Financial Measures below. Investors should use our non-GAAP financial measures only in conjunction with our GAAP results.

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For discussion of our FY'21 results and comparison to our FY'20 results, refer to Management's Discussion and Analysis of Financial Conditions and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021.

Impact of Foreign Currency Exchange on Results of Operations

Approximately 55% of our revenue and 40% of our expenses are transacted in currencies other than the U.S. Dollar. Because we report our results of operations in U.S. Dollars, currency translation, particularly changes in the Euro, Yen, Shekel, and Rupee relative to the U.S. Dollar, affects our reported results. Changes in foreign currency exchange rates have been a headwind to reported results in FY’22.

The results of operations in the table above, and the tables and discussions below about revenue by line of business, product group, and geographic region present both actual percentage changes year over year and percentage changes on a constant currency basis. Our constant currency disclosures are calculated by multiplying the results in local currency for FY'22 and FY'21 by the exchange rates in effect on September 30, 2021. If FY'22 reported results were converted into U.S. dollars using the rates in effect as of September 30, 2021, ARR as of September 30, 2022 would have been higher by $134 million and operating income in FY'22 would have been $27 million higher.

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Revenue

Under ASC 606, the volume, mix, and duration of contract types (support, SaaS, on-premises subscription) starting or renewing in any given period may have a material impact on revenue in the period, and as a result can impact the comparability of reported revenue period-over-period. We recognize revenue for the license portion of on-premises subscription contracts up front when we deliver the licenses to the customer, typically on the start date, and we recognize revenue on the support element of on-premises subscription contracts and stand-alone support contracts ratably over the term. We continue to convert existing support contracts to on-premises subscriptions, resulting in a shift to up-front recognition of on-premises subscription license revenue in the period converted compared to ratable recognition for a perpetual support contract. Revenue from our cloud services (primarily SaaS) contracts is recognized ratably. As we continue to expand our SaaS offerings and release additional cloud functionality into our products, and customers begin to migrate from on-premises subscriptions to SaaS products, we expect that over time a higher portion of our revenue will be recognized ratably. Given the different mix, duration and volume of new and renewing contracts in any period, year-over-year or sequential revenue comparisons can vary significantly.

Revenue by Line of Business

The strengthening of the U.S. dollar compared to foreign currencies had a substantial impact on our revenue growth in FY'22. On an actual currency basis, FY'22 revenue increased $126 million (7%), compared to an increase of $202 million (11%) on a constant currency basis.

Software revenue increased in FY’22 compared to FY’21 due to growth of Windchill and Arena revenue in the Americas and contribution from the recently acquired Codebeamer business in Europe, offset by a decline in Creo revenue primarily driven by foreign currency fluctuations in Europe and changes in contract durations. In FY'22, our average durations for on-premises subscriptions starting in the year decreased slightly, resulting in a reduced revenue benefit compared to FY'21, which benefited from significant increases in average contractual durations due to business rule changes.

Professional services revenue in FY’22 compared to FY'21 reflects an increase in revenue associated with large PLM consulting engagements, particularly with automotive, aerospace and defense and consumer electronics customers. Professional services revenue in the first half of FY’21 was negatively impacted by services delivery challenges associated with the COVID-19 pandemic.

Our long-term expectation is that professional services revenue will trend down over time as we migrate more services engagements to our partners and deliver products that require less consulting and training services. As described in Part I, Item 1. Business above, in the second half of FY'22, we accelerated this strategy through the sale of a portion of our PLM services business to ITC Infotech.

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Revenue and ARR by Product Group

Windchill software revenue increased by 12% (16% constant currency), driven by a significant increase in on-premises subscription license revenue and an increase in cloud services revenue. Windchill ARR increased 10% (19% constant currency) in FY'22 compared to FY'21.

Arena software revenue increased by 122% (actual and constant currency), driven by an increase in cloud services revenue and an increase in on-premises subscription license revenue. Arena was acquired in January 2021, so it did not contribute to FY'21 revenue for the full year and purchase accounting adjustments to acquired deferred revenue had a greater impact on FY'21 revenue than FY'22. Arena ARR increased by 27% (actual and constant currency) in FY'22 compared to FY'21.

IIoT software revenue increased by 7% (10% constant currency) driven by an increase in cloud services revenue. IIoT ARR increased 14% (21% constant currency) in FY'22 compared to FY'21.

The Codebeamer business, which we acquired in the third quarter, performed well and added a point of ARR growth, taking constant currency ARR growth to 16% for the fourth quarter and full year. Codebeamer generated $9 million of revenue in FY'22, with $6 million of on-premises subscription revenue and $2 million of perpetual support revenue. Codebeamer ARR as of September 30, 2022 was $16 million ($18 million on a constant currency basis).

Creo software revenue decreased by 1% primarily driven by the effect of foreign currency headwinds in Europe. Creo software revenue increased 4% on a constant currency basis. Creo ARR was flat (increased 11% in constant currency) in FY'22 compared to FY'21.

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Software Revenue & ARR by Geographic Region

A significant portion of our software revenue is generated outside the U.S. In both FY’22 and FY’21, approximately 40% to 45% of software revenue was generated in the Americas, 35% to 40% in Europe, and 15% to 20% in Asia Pacific.

Americas software revenue growth in FY’22 was driven by Windchill revenue growth of 23%, Arena revenue growth of 133%, and IIoT revenue growth of 10%. The increase in revenue from Arena includes the effect of purchase accounting adjustments to reduce acquired deferred revenue. Americas ARR was up 17%.

Europe software revenue declined in FY’22, driven by a $48 million foreign currency impact associated with the strengthening of the U.S. Dollar compared to foreign currencies. Creo revenue decreased 5% (2% increase in constant currency), partially offset by Windchill revenue growth of 4% (12% constant currency) and the addition of Codebeamer revenue. ARR in Europe was up 16% constant currency.

Asia Pacific software revenue growth in FY’22 included a $19 million foreign currency impact associated with the strengthening of the US Dollar compared to foreign currencies. Creo revenue grew 4% (11% constant currency) and Windchill revenue grew 3% (9% constant currency). ARR in Asia Pacific was up 13% constant currency.

Gross Margin

(1) Non-GAAP financial measures are reconciled to GAAP results under Non-GAAP Financial Measures below.

The strengthening of the U.S. dollar compared to foreign currencies had a substantial impact on our gross margin increase in FY'22. On an actual currency basis, FY'22 gross margin increased $111 million (8%), compared to an increase of $176 million (12%) on a constant currency basis.

License gross margin increased in FY’22 compared to FY’21 due to an increase in license revenue of $44.6 million and a decrease in cost of license of $12.5 million, which was driven by lower amortization expense, royalty expense and compensation costs.

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Support and cloud services gross margin increased in FY’22 compared to FY’21 due to increases in support and cloud services revenue of $76.3 million, partially offset by increases in cost of support and cloud services of $20.7 million, which were driven by higher compensation, maintenance and hosting costs.

Professional services gross margin decreased in FY’22 compared to FY’21 due to increases in professional services costs of $6.7 million, including $5.1 million of stock-based compensation expense recognized in FY'22 related to the sale of a portion of our PLM services business in Q3'22, partially offset by a $5.3 million increase in revenue.

Operating Expenses

The strengthening of the U.S. dollar compared to foreign currencies had a substantial reduction to our operating expense increase in FY'22. On an actual currency basis, FY'22 operating expenses increased $45 million (4%), compared to an increase of $67 million (6%) on a constant currency basis.

Total headcount decreased by 3% in FY'22 to 6,503 from 6,709 at the end of FY'21.

Operating expenses in FY'22 compared to FY'21 increased primarily due to the following:

partially offset by:

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Interest Expense

Interest expense includes interest under our credit facility and senior notes. Interest expense was higher in FY'22 than FY'21. We had $1,359 million of total debt at September 30, 2022, compared to $1,450 million at September 30, 2021. We repaid $355 million of our revolving credit facility in FY'22, offset by $264 million borrowed at the end of April to fund the acquisition of the Codebeamer business. Loans under the credit facility bear interest at variable rates which reset every 30 to 180 days. As of September 30, 2022, the annual rate for borrowings under the credit facility was 4.1%, which has subsequently increased to 5.7%. For additional detail on the changes in our debt structure, see Note 9. Debt, included in the Notes to Consolidated Financial Statements in this Annual Report.

The average interest rate on our total borrowings was 3.4% in FY'22 and 3.3% in FY'21.

Other Income (Expense)

Interest income represents earnings on the investment of our available cash and marketable securities.

The decrease in Other income, net, in FY’22 over FY’21 was driven by a FY'21 credit of $69 million associated with unrealized gains related to an equity investment in a publicly-traded company. In FY'22, the value of that equity investment decreased, resulting in a $35 million charge. That FY'22 charge was offset by a gain on the sale of a portion of our PLM services business of $30 million and $6 million of gains on the sale of other assets and investments.

Income Taxes

In FY’22 and FY’21, our effective tax rate is impacted by our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland and the Cayman Islands. In FY’22 and FY’21 the foreign rate differential predominantly relates to those earnings. In addition to the foreign rate differential, our tax rate differed from the statutory federal income tax rate due to the net effects of the Global Intangible Low-Taxed Income (GILTI) and Foreign Derived Intangible Income (FDII) regimes (together referred to as U.S. Tax reform), and the excess tax benefit related to stock-based compensation.

Additionally in FY’22, our results include tax expense relating to the book over tax basis difference on goodwill disposed of as part of the sale of a portion of our PLM service business. As a result of the net effect of these items in 2022, our effective tax rate did not differ significantly from the U.S. federal income tax rate.

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In FY’21, our tax rate includes a benefit due to the release of the valuation allowance on the majority of our U.S. net deferred tax assets.

Our results for the twelve months ended September 30, 2021, include a charge of $37.3 million related to the effects of a tax matter in the Republic of Korea (South Korea) of $34.4 million, and the resulting impact on U.S. income taxes of $2.9 million. The charge related to an assessment with respect to various tax issues, primarily foreign withholding taxes, in South Korea. We made additional payments of approximately $20 million to the tax authorities in South Korea in FY’21 for the years 2016 to 2021.

Liquidity and Capital Resources

Cash, cash equivalents and restricted cash

We invest our cash with highly rated financial institutions and in diversified domestic and international money market mutual funds. cash and cash equivalents include highly liquid investments with original maturities of three months or less. At September 30, 2022, cash and cash equivalents totaled $272 million, compared to $327 million at September 30, 2021.

A significant portion of our cash is generated and held outside the U.S. As of September 30, 2022, we had cash and cash equivalents of $11 million in the U.S., $105 million in Europe, $128 million in Asia Pacific (including India) and $28 million in other non-U.S. countries. We have substantial cash requirements in the U.S., but we believe that the combination of our existing U.S. cash and cash equivalents, marketable securities, our ability to repatriate cash to the U.S., future U.S. operating cash flows and cash available under our credit facility will be sufficient to meet our ongoing U.S. operating expenses and known capital requirements.

Cash provided by operating activities

Cash provided by operating activities was $435 million in FY'22 compared to $369 million in FY'21. The year-over-year increase is primarily due to approximately $170 million of higher cash collections, offset by $30 million more in salary and salary-related payments, a $57 million increase in disbursements largely related to prepayments made in FY'22, and a $12 million increase in tax-related payments.

Restructuring payments totaled $41 million in FY'22, compared to $15 million in FY'21. Cash paid for income taxes was $55 million in FY'22 compared to $58 million in FY'21.

Cash used in investing activities

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Cash used in investing activities in FY'22 reflects $278 million ($264 million of which we borrowed under our credit facility) used to acquire the Codebeamer business in FY'22, compared to $718 million used in FY’21 for the Arena acquisition, offset by FY'22 proceeds from the sale of a portion of our PLM services business of $33 million and proceeds from the sale of investments of $47 million. For additional detail on our acquisitions, see Note 6. Acquisitions and Disposition of Business of Notes to Consolidated Financial Statements in this Annual Report.

Cash (used in) provided by financing activities

Cash used in financing activities in FY’22 reflects borrowings of $264 million, offset by repayments of $355 million under our credit facility, repurchases of common stock of $125 million, payments of withholding taxes related to stock-based awards of $69 million and proceeds from the issuance of common stock of $21 million. In FY'21, net borrowings of $600 million were offset by $168 million of repayments under our credit facility, repurchases of common stock of $30 million, and payments of withholding taxes related to stock-based awards of $53 million.

Outstanding Debt

As of September 30, 2022, we had:

As of September 30, 2022, we were in compliance with all financial and operating covenants of the credit facility and the note indentures. Any failure to comply with such covenants under the credit facility would prevent us from being able to borrow additional funds under the credit facility, and, as with any failure to comply with such covenants under the note indentures, could constitute a default that could cause all amounts outstanding to become due and payable immediately. Loans under the credit facility bear interest at variable rates which reset every 30 to 180 days. As of September 30, 2022, the annual rate for borrowings outstanding was 4.1%, which has subsequently increased to 5.7%.

Our credit facility and our Senior Notes are described in Note 9. Debt of Notes to the Consolidated Financial Statements in this Annual Report.

Share Repurchase Authorization

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 $1 billion of our common stock through September 30, 2023. We may use cash from operations and borrowings under our credit facility to make any such repurchases. All shares of our common stock repurchased are automatically restored to the status of authorized and unissued.

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In FY'22 and in FY'21 we repurchased 1.05 million shares for $125 million and approximately 0.23 million shares in the open market for $30 million, respectively.

Our long-term goal is to return approximately 50% of our free cash flow to shareholders via share repurchases, while also taking into consideration the interest rate environment and strategic initiatives and acquisitions, which could cause us to reduce, suspend, or cease repurchases.

Expectations for Fiscal 2023

We believe that existing cash and cash equivalents, together with cash generated from operations and amounts available under the credit facility and otherwise, will be sufficient to meet our working capital and capital expenditure requirements (which we expect to be approximately $20 million in FY’23) through at least the next twelve months and to meet our known long-term capital requirements.

Our expected uses and sources of cash could change, our cash position could be reduced, and we could incur additional debt obligations if we engage in strategic transactions, retire debt, or repurchase shares, any of which could be commenced, suspended, or completed at any time. Any share repurchases or debt retirement will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. Such debt retirement or issuance, share repurchases, or strategic transactions may be material. We regularly borrow under our credit facility to make strategic acquisitions and expect to continue to do so, and may substantially increase our indebtedness to pursue strategic acquisitions, which would increase our debt repayment obligations, including related interest obligations.

Contractual Obligations

At September 30, 2022, our future contractual obligations were related to debt, leases, pension liabilities, unrecognized tax benefits, and purchase obligations. See Note 9. Debt, Note 19. Leases, Note 14. Pension Plans, and Note 8. Income Taxes of Notes to Consolidated Financial Statements in this Annual Report for information about those obligations, which Notes are incorporated by reference into this section. Our purchase obligations were approximately $161.4 million, with $64.2 million expected to be paid in FY'23 and $97.2 million thereafter. Purchase obligations represent minimum commitments due to third parties, including royalty contracts, research and development contracts, telecommunication contracts, information technology maintenance contracts in support of internal-use software and hardware, financing leases, operating leases with original terms of less than 12 months, and other marketing and consulting contracts. Contracts for which our commitment is variable, based on volumes, with no fixed minimum quantities, and contracts that can be canceled without payment penalties are not included in the purchase obligation amounts above. The purchase obligations included above are in addition to amounts included in Current liabilities and Prepaid expenses recorded on our September 30, 2022 Consolidated Balance Sheet.

As of September 30, 2022, we had letters of credit and bank guarantees outstanding of approximately $15 million (of which $0.5 million was collateralized).

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Operating Measure

ARR

ARR (Annual Run Rate) represents the annualized value of our portfolio of active subscription software, cloud, SaaS, and support contracts as of the end of the reporting period.

We believe ARR is a valuable operating metric to measure the health of a subscription business because it captures expected subscription and support cash generation from customers. Because this measure represents the annualized value of customer contracts as of a point in time, it does not represent revenue for any particular period or remaining revenue that will be recognized in future periods.

Non-GAAP Financial Measures

The non-GAAP financial measures presented in the discussion of our results of operations and the respective most directly comparable GAAP measures are:

Free cash flow is cash flow from operations net of capital expenditures, which are expenditures for property and equipment and consist primarily of facility improvements, office equipment, computer equipment, and software. We believe that free cash flow, in conjunction with cash from operations, is a useful measure of liquidity since capital expenditures are a necessary component of ongoing operations.

The non-GAAP financial measures other than free cash flow exclude, as applicable: stock-based compensation expense; amortization of acquired intangible assets; acquisition and transaction-related charges included in general and administrative expenses; restructuring and other charges, net; non-operating charges; and income tax adjustments.

The items excluded from these non-GAAP financial measures are normally included in the comparable measures calculated and presented in accordance with GAAP. Our management excludes these items when evaluating our ongoing performance and/or predicting our earnings trends, and therefore excludes them when presenting non-GAAP financial measures. Management uses non-GAAP financial measures in conjunction with our GAAP results, as should investors.

Stock-based compensation is a non-cash expense relating to stock-based awards issued to executive officers, employees and outside directors, consisting of restricted stock units. We exclude this expense as it is a non-cash expense and we assess our internal operations excluding this expense and believe it facilitates comparisons to the performance of other companies in our industry.

Amortization of acquired intangible assets is a non-cash expense that is impacted by the timing and magnitude of our acquisitions. We believe the assessment of our operations excluding these costs is relevant to our assessment of internal operations and comparisons to the performance of other companies in our industry.

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Acquisition and transaction-related charges included in General and administrative expenses are direct costs of potential and completed acquisitions and expenses related to acquisition integration activities, including transaction fees, due diligence costs, severance and professional fees. Subsequent adjustments to our initial estimated amount of contingent consideration associated with specific acquisitions are also included within acquisition and transaction-related charges. Other transactional charges include third-party costs related to structuring unusual transactions. We do not include these costs when reviewing our operating results internally. The occurrence and amount of these costs will vary depending on the timing and size of acquisitions and transactions.

Restructuring and other charges, net includes excess facility restructuring charges (credits); impairment and accretion expense charges related to the lease assets of exited facilities; sublease income from previously impaired facilities; and severance costs resulting from reductions of personnel and third-party professional consulting fees related to modifications of our business strategy. These costs may vary in size based on our restructuring plan.

Non-operating charges (credits) includes gains or losses associated with sales or changes in value of assets or liabilities which are generally investing or financing in nature, and are inconsistent with our ordinary operating activities. In FY'22, we recorded gains associated with the sale of assets, including the sale of a portion of our PLM services business. Additionally in FY'22, we recorded a loss associated with the reduction in value of an equity investment in a publicly-traded company. In FY'21, we recorded a gain related to the change in value of an equity investment in a publicly-traded company.

Income tax adjustments include the tax impact of the items above and assumes that we are profitable on a non-GAAP basis in the U.S. and one foreign jurisdiction. It also eliminates the effect of the valuation allowance recorded against our net deferred tax assets in those jurisdictions. Additionally, we exclude other material tax items that we do not include when reviewing our operating results internally.

We use these non-GAAP financial measures, and we believe that they assist our investors, to make period-to-period comparisons of our operational performance because they provide a view of our operating results without items that are not, in our view, indicative of our core operating results. We believe that these non-GAAP financial measures help illustrate underlying trends in our business, and we use the measures to establish budgets and operational goals (communicated internally and externally) for managing our business and evaluating our performance. We believe that providing non-GAAP financial measures also affords investors a view of our operating results that may be more easily compared to the results of other companies in our industry that use similar financial measures to supplement their GAAP results.

The items excluded from the non-GAAP financial measures often have a material impact on our financial results and such items often recur. Accordingly, the non-GAAP financial measures included in this Annual Report should be considered in addition to, and not as a substitute for or superior to, the comparable measures prepared in accordance with GAAP. The following tables reconcile each of these non-GAAP financial measures to its most closely comparable GAAP measure on our financial statements.

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Operating margin impact of non-GAAP adjustments:

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Critical Accounting Policies and Estimates

We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our reported revenues, results of operations, and net income, as well as on the value of certain assets and liabilities on our balance sheet. These estimates, assumptions and judgments are made based on our historical experience and on other assumptions that we believe to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time.

The accounting policies, methods and estimates used to prepare our financial statements are described generally in Note 2. Summary of Significant Accounting Policies of Notes to Consolidated Financial Statements in this Annual Report. The most important accounting judgments and estimates that we made in preparing the financial statements involved:

A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make subjective or complex judgments that could have a material effect on our financial condition and results of operations. Critical accounting policies require us to make assumptions about matters that are uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimates that are reasonably likely to occur, may have a material impact on our financial condition or results of operations. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates.

Accounting policies, guidelines and interpretations related to our critical accounting policies and estimates are generally subject to numerous sources of authoritative guidance and are often reexamined by accounting standards rule makers and regulators. These rule makers and/or regulators may promulgate interpretations, guidance or regulations that may result in changes to our accounting policies, which could have a material impact on our financial position and results of operations.

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Revenue Recognition

We record revenues in accordance with the guidance provided by ASC 606, Revenue from Contracts with Customers. For a full description of our revenue accounting policy, refer to Note 2. Summary of Significant Accounting Policies, included in the Notes to Consolidated Financial Statements in this Annual Report.

Our sources of revenue include: (1) subscriptions, (2) perpetual licenses, (3) support for perpetual licenses and (4) professional services. Subscriptions include term-based on-premises licenses, Software-as-a-Service (SaaS), and hosting services.

Judgments and Estimates

Determination of performance obligations. Our subscriptions are frequently sold as a bundle of products and services, typically pairing on-premises term software licenses with support and/or cloud services over the same term. On-premises software is typically determined to be a distinct performance obligation and is thus recognized separately from the support and/or cloud components. On-premises license software revenue is generally recognized at the point in time that the software is made available to the customer, while the support and cloud software revenue components are recognized over the term of the contract. In cases where subscriptions include cloud functionality and on-premises software, an assessment has been performed to determine whether the cloud services are distinct from the on-premises software. In the substantial majority of instances, cloud services provide incremental functionality to customers and have been considered distinct and recognized separately from the on-premises software. This assessment could have a significant impact on the timing of revenue recognition and may change as our product offerings evolve.

Allocation of transaction price. We estimate the standalone selling price of each identified performance obligation and use that estimate to allocate the transaction price among said performance obligations. The estimated standalone selling price is determined using all information reasonably available to us, including market conditions and other observable inputs. Significant judgment is used in determining the standalone selling prices of the on-premises license, support, and cloud components of our subscription products. These estimates are subject to change as our product offerings change and could have a significant impact due to the difference in the timing of revenue recognition for on-premises licenses and support and/or cloud.

Right to exchange. Our multi-year, non-cancellable on-premises subscription contracts provide customers with an annual right to exchange software within the original subscription with other software. We account for this right as a liability. For most contracts, we use the expected value method to determine the liability associated with this right across a portfolio of contracts. Where contracts are outside of the standard portfolio of contracts due to contract size, longer contract duration, or other unique contractual terms, we use the most likely amount method to determine the liability for each individual contract. In both circumstances, the transaction price is constrained based on our estimates, which impacts the amount of revenue recognized. Changes in these estimates could significantly impact revenue for any given period.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to calculate our income tax expense based on taxable income by jurisdiction. There are many transactions and calculations about which the ultimate tax outcome is uncertain; as a result, our calculations involve estimates by management. Some of these uncertainties arise as a consequence of revenue-sharing, cost-reimbursement and transfer pricing arrangements among related entities and the differing tax treatment of revenue and cost items across various jurisdictions. If we were compelled to revise or to account differently for our arrangements, that revision could affect our recorded tax liabilities.

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The income tax accounting process also involves estimating our actual current tax liability, together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that it is more likely than not that all or a portion of our deferred tax assets will not be realized, we must establish a valuation allowance as a charge to income tax expense.

As of September 30, 2022, we have a valuation allowance of $17.8 million against net deferred tax assets in the U.S. and a valuation allowance of $4.5 million against net deferred tax assets in certain foreign jurisdictions. We have concluded, based on the weight of available evidence, that a full valuation allowance is not required against our U.S. net deferred tax assets as they are more likely than not to be realized in the future. We will continue to reassess our valuation allowance requirements each financial reporting period.

The valuation allowance recorded against net deferred tax assets of certain foreign jurisdictions is established primarily for our capital loss carryforwards, the majority of which do not expire. However, there are limitations imposed on the utilization of such capital losses that could further restrict the recognition of any tax benefits.

Prior to the passage of the U.S. Tax Act, the Company asserted that substantially all of the undistributed earnings of its foreign subsidiaries were considered indefinitely invested and accordingly, no deferred taxes were provided. Pursuant to the provisions of the U.S. Tax Act, these earnings were subjected to a one-time transition tax and there is therefore no longer a material cumulative basis difference associated with the undistributed earnings. We maintain our assertion to permanently reinvest these earnings outside the U.S. unless repatriation can be done substantially tax-free, with the exception of a foreign holding company formed in 2018 and our Taiwan subsidiary. If we decide to repatriate any additional non-U.S. earnings in the future, we may be required to establish a deferred tax liability on such earnings. The amount of unrecognized deferred tax liability on the undistributed earnings would not be material.

In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the Internal Revenue Service (IRS) in the U.S. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. We are currently under audit by tax authorities in several jurisdictions. Audits by tax authorities typically involve examination of the deductibility of certain permanent items, transfer pricing, limitations on net operating losses and tax credits. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in material changes in our estimates.

Valuation of Assets and Liabilities Acquired in Business Combinations

In accordance with business combination accounting, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. Determining these fair values requires management to make significant estimates and assumptions, especially with respect to intangible assets.

Our identifiable intangible assets acquired consist of developed technology, core technology, tradenames, customer lists and contracts, and software support agreements and related relationships. Developed technology consists of products that have reached technological feasibility. Core technology represents a combination of processes, inventions and trade secrets related to the design and development of acquired products. Customer lists and contracts and software support agreements and related relationships represent the underlying relationships and agreements with customers of the acquired company’s installed base. We have generally valued intangible assets using a discounted cash flow model. Critical estimates in valuing certain of the intangible assets include but are not limited to:

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In addition, we estimate the useful lives of our intangible assets based upon the expected period over which we anticipate generating economic benefits from the related intangible asset.

Net tangible assets consist of the fair values of tangible assets less the fair values of assumed liabilities and obligations. Except for deferred revenues, net tangible assets were generally valued by us at the respective carrying amounts recorded by the acquired company, if we believed that their carrying values approximated their fair values at the acquisition date. For acquisitions completed prior to FY'22, the values assigned to deferred revenue reflect an amount equivalent to the estimated cost plus an appropriate profit margin to perform the services related to the acquired company’s software support contracts. During FY'22, we adopted ASU 2021-08, whereby deferred revenue for acquisitions completed in FY'22 reflect the amounts that would have been deferred as of the acquisition date in accordance with ASC 606.

In addition, uncertain tax positions and tax-related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date and we reevaluate these items quarterly with any adjustments to our preliminary estimates being recorded to goodwill provided that we are within the measurement period (up to one year from the acquisition date) and we continue to collect information in order to determine their estimated values. Subsequent to the measurement period or our final determination of the estimated value of uncertain tax positions or tax-related valuation allowances, whichever comes first, changes to these uncertain tax positions and tax-related valuation allowances will affect our provision for income taxes in our Consolidated Statements of Operations.

Our estimates of fair value are based upon assumptions believed to be reasonable at that time, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur, which may affect the accuracy or validity of such assumptions, estimates or actual results.

When events or changes in circumstances indicate that the carrying value of a finite-lived intangible asset may not be recoverable, we perform an assessment of the asset for potential impairment. This assessment is based on projected undiscounted future cash flows over the asset’s remaining life. If the carrying value of the asset exceeds its undiscounted cash flows, we record an impairment loss equal to the excess of the carrying value over the fair value of the asset, determined using projected discounted future cash flows of the asset.

Recent Accounting Pronouncements

In accordance with recently issued accounting pronouncements, we will be required to comply with certain changes in accounting rules and regulations, none of which are expected to have a material impact on our consolidated financial statements. Refer to Note 2. Summary of Significant Accounting Policies of Notes to the Consolidated Financial Statements in this Annual Report for all recently issued accounting pronouncements, which is incorporated herein by reference.

Off-Balance Sheet Arrangements

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated (to the extent of our ownership interest therein) into our financial statements. We have not entered into any transactions with unconsolidated entities whereby we have subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us.

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ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

We face exposure to financial market risks, including adverse movements in foreign currency exchange rates and changes in interest rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

Foreign currency exchange risk

Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Our most significant foreign currency exposures relate to Western European countries, Japan, Israel, China and Canada. We enter into foreign currency forward contracts to manage our exposure to fluctuations in foreign exchange rates that arise from receivables and payables denominated in foreign currencies. We do not enter into or hold foreign currency derivative financial instruments for trading or speculative purposes, nor do we enter into derivative financial instruments to hedge future cash flows or forecast transactions.

Our non-U.S. revenues generally are transacted through our non-U.S. subsidiaries and typically are denominated in their local currency. In addition, expenses that are incurred by our non-U.S. subsidiaries typically are denominated in their local currency. Approximately 55% of our revenue and 40% of our expenses were transacted in currencies other than the U.S. dollar. Currency translation affects our reported results because we report our results of operations in U.S. Dollars. Historically, our most significant currency risk has been changes in the Euro and Japanese Yen relative to the U.S. Dollar. Based on current revenue and expense levels (excluding restructuring charges and stock-based compensation), a $0.10 change in the USD to EUR exchange rate and a 10 Yen change in the Yen to USD exchange rate would impact operating income by approximately $32 million and $12 million, respectively.

Our exposure to foreign currency exchange rate fluctuations arises in part from intercompany transactions, with most intercompany transactions occurring between a U.S. dollar functional currency entity and a foreign currency denominated entity. Intercompany transactions typically are denominated in the local currency of the non-U.S. dollar functional currency subsidiary in order to centralize foreign currency risk. Also, both PTC (the parent company) and our non-U.S. subsidiaries may transact business with our customers and vendors in a currency other than their functional currency (transaction risk). In addition, we are exposed to foreign exchange rate fluctuations as the financial results and balances of our non-U.S. subsidiaries are translated into U.S. dollars (translation risk). If sales to customers outside the United States increase, our exposure to fluctuations in foreign currency exchange rates will increase.

Our foreign currency risk management strategy is principally designed to mitigate the future potential financial impact of changes in the U.S. dollar value of balances denominated in foreign currency, resulting from changes in foreign currency exchange rates. Our foreign currency hedging program uses forward contracts to manage the foreign currency exposures that exist as part of our ongoing business operations. The contracts are primarily denominated in Japanese Yen and European currencies, and have maturities of less than four months.

The majority of our foreign currency forward contracts are not designated 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 currency denominated receivables and payables are included in foreign currency net losses.

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As of September 30, 2022 and 2021, we had outstanding forward contracts for derivatives not designated as hedging instruments with notional amounts equivalent to the following: