Stock-based Compensation

We measure the cost of employee services received in exchange for restricted stock unit (RSU) awards based on the fair value of RSU awards on the date of grant. That cost is recognized over the period during which an employee is required to provide service in exchange for the award.

Our equity incentive plan provides for grants of nonqualified and incentive stock options, common stock, restricted stock, RSUs and stock appreciation rights to employees, directors, officers and consultants. We award RSUs as the principal equity incentive awards, including certain performance-based awards that are earned based on achievement of performance criteria established by the Compensation Committee of our Board of Directors. Each RSU represents the contingent right to receive one share of our common stock.

Our employee stock purchase plan (ESPP), initiated in the fourth quarter of 2016, allows eligible employees to contribute up to 10% of their base salary, up to a maximum of $25,000 per year and subject to any other plan limitations, toward the purchase of our common stock at a discounted price. The purchase price of the shares on each purchase date is equal to 85% of the lower of the fair market value of our common stock on the first and last trading days of each offering period. The ESPP is qualified under Section 423 of the Internal Revenue Code. We estimate the fair value of each purchase right under the ESPP on the date of grant using the Black-Scholes option valuation model and use the straight-line attribution approach to record the expense over the six-month offering period.



Restricted stock unit activity for the nine months ended July 1, 2017	Shares		Weighted Average Grant Date Fair Value (Per Share)
	(in thousands)
Balance of outstanding restricted stock units October 1, 2016	3,776		$	37.30
Granted	1,932		$	51.24
Vested	(1,564	)	$	36.02
Forfeited or not earned	(622	)	$	37.51
Balance of outstanding restricted stock units July 1, 2017	3,522		$	45.48



	Restricted Stock Units
Grant Period	Target TSR Units (1)	Performance-based RSUs (2)	Service-based RSUs (3)
	(Number of Units in thousands)
First nine months of 2017	358	325	1,249

_________________


(1)	The TSR units were granted to our executive officers pursuant to the terms described below.


(2)	The performance-based RSUs were granted to our executive officers and are eligible to vest based on the achievement of performance criteria for fiscal 2017 established by the Compensation Committee at the time of grant. Shares not earned will be forfeited. The shares earned will vest in three substantially equal installments on November 15, 2017, November 15, 2018 and November 15, 2019.


(3)	The service-based RSUs were granted to employees, our executive officers and our directors. All service-based RSUs will vest in three substantially equal annual installments on or about the anniversary of the date of grant.

In the first nine months of 2017, we granted the target performance-based TSR units ("target RSUs") shown in the table above to our executive officers. These RSUs are eligible to vest based upon our total shareholder return relative to a peer group (the “TSR units”), measured annually over a three year period. The number of TSR units to vest over the three year period will be determined based on the performance of PTC stock relative to the stock performance of an index of PTC peer companies established as of the grant date, as determined at the end of three measurement periods ending on September 30, 2017, 2018 and 2019, respectively. The shares earned for each period will vest on November 15 following each measurement period, up to a maximum of two times the number of target RSUs (up to a maximum of 499 thousand shares). No vesting will occur in a period unless an annual threshold requirement is achieved. The employee, subject to certain retirement provisions, must remain employed by PTC through the applicable vest date for any RSUs to vest, but in no event will any RSUs vest if the performance criteria are not achieved. If the return to PTC shareholders is negative but still meets or exceeds the peer group indexed return, a maximum of 100% of the target RSUs will vest for the measurement period. TSR units not earned in either of the first two measurement periods are eligible to be earned in the third measurement period.

The weighted average fair value of the TSR units was $68.02 per target RSU on the grant date. The fair value of the TSR units was determined using a Monte Carlo simulation model, a generally accepted statistical technique used to simulate a range of possible future stock prices for PTC and the peer group. The method uses a risk-neutral framework to model future stock price movements based upon the risk-free rate of return, the volatility of each entity, and the pairwise correlations of each entity being modeled. The fair value for each simulation is the product of the payout percentage determined by PTC’s TSR rank against the peer group, the projected price of PTC stock, and a discount factor based on the risk-free rate.

The significant assumptions used in the Monte Carlo simulation model were as follows:



Average volatility of peer group	29.3	%
Risk-free interest rate	0.99	%
Dividend yield	—	%

Compensation expense recorded for our stock-based awards was classified in our Consolidated Statements of Operations as follows:



	Three months ended				Nine months ended
	July 1, 2017		July 2, 2016		July 1, 2017		July 2, 2016
	(in thousands)
Cost of license and subscription revenue	$	347	$	195	$	954	$	552
Cost of support revenue	1,139		963		3,638		3,611
Cost of professional services revenue	1,505		1,342		4,500		4,072
Sales and marketing	3,296		3,195		11,047		11,254
Research and development	2,805		2,531		9,753		7,578
General and administrative	7,482		5,570		26,247		24,754
Total stock-based compensation expense	$	16,574	$	13,796	$	56,139	$	51,821

Stock-based compensation expense in the third quarter and first nine months of 2017 includes $0.9 million and $2.2 million, respectively, related to the ESPP. Stock-based compensation expense in the first quarter of 2016 included $10 million related to modifications of certain performance-based RSUs previously granted under our long-term incentive programs.