UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(MARK ONE)

 

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2008

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

FOR THE TRANSITION PERIOD FROM          TO          

 

COMMISSION FILE NUMBER: 0-19807

 

SYNOPSYS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

56-1546236

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

700 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043

(Address of principal executive offices, including zip code)

 

(650) 584-5000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (l) 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 x  No o

 

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

142,702,930 shares of Common Stock as of June 6, 2008

 

 



 

SYNOPSYS, INC.
QUARTERLY REPORT ON FORM 10-Q
APRIL 30, 2008
TABLE OF CONTENTS

 

 

 

 

Page

PART I.

 

Financial Information

 

1

ITEM 1.

 

Financial Statements

 

1

 

 

Unaudited Condensed Consolidated Balance Sheets

 

1

 

 

Unaudited Condensed Consolidated Statements of Operations

 

2

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

 

3

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

4

ITEM 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

13

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

25

ITEM 4.

 

Controls and Procedures

 

25

PART II

 

Other Information

 

26

ITEM 1

 

Legal Proceedings

 

26

ITEM 1A.

 

Risk Factors

 

26

ITEM 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

33

ITEM 4.

 

Submission of Matters to a Vote of Security Holders

 

33

ITEM 6.

 

Exhibits

 

34

Signatures

 

 

 

35

 

i



 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value amounts)

 

 

 

April 30,
2008

 

October 31,
2007

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

574,889

 

$

579,327

 

Short-term investments

 

242,609

 

405,126

 

Total cash, cash equivalents and short-term investments

 

817,498

 

984,453

 

Accounts receivable, net

 

171,993

 

123,900

 

Deferred income taxes

 

127,345

 

123,165

 

Income taxes receivable

 

42,724

 

42,525

 

Prepaid expenses and other current assets

 

57,337

 

53,496

 

Total current assets

 

1,216,897

 

1,327,539

 

Property and equipment, net

 

127,223

 

131,866

 

Goodwill

 

765,576

 

767,087

 

Intangible assets, net

 

54,778

 

78,792

 

Long-term deferred income taxes

 

168,056

 

216,642

 

Other assets

 

97,629

 

95,411

 

Total assets

 

$

2,430,159

 

$

2,617,337

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

176,746

 

$

246,209

 

Accrued income taxes

 

10,280

 

207,572

 

Deferred revenue

 

522,078

 

577,295

 

Total current liabilities

 

709,104

 

1,031,076

 

 

 

 

 

 

 

Deferred compensation and other liabilities

 

83,322

 

84,648

 

Long-term accrued income taxes

 

137,597

 

 

Long-term deferred revenue

 

65,310

 

65,220

 

Total liabilities

 

995,333

 

1,180,944

 

Stockholders’ equity:

 

 

 

 

 

Preferred Stock, $0.01 par value: 2,000 shares authorized; none outstanding

 

 

 

Common Stock, $0.01 par value: 400,000 shares authorized; 141,756 and 146,365 shares outstanding, respectively

 

1,417

 

1,464

 

Capital in excess of par value

 

1,435,900

 

1,401,965

 

Retained earnings

 

342,424

 

263,977

 

Treasury stock, at cost: 15,512 and 10,867 shares, respectively

 

(348,332

)

(234,918

)

Accumulated other comprehensive income

 

3,417

 

3,905

 

Total stockholders’ equity

 

1,434,826

 

1,436,393

 

Total liabilities and stockholders’ equity

 

$

2,430,159

 

$

2,617,337

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

1



 

SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Revenue:

 

 

 

 

 

 

 

 

 

Time-based license

 

$

278,220

 

$

243,096

 

$

546,080

 

$

494,702

 

Upfront license

 

12,214

 

14,624

 

24,735

 

28,127

 

Maintenance and service

 

34,119

 

35,208

 

69,203

 

70,309

 

Total revenue

 

324,553

 

292,928

 

640,018

 

593,138

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

License

 

41,709

 

34,657

 

82,107

 

70,177

 

Maintenance and service

 

16,167

 

15,550

 

32,046

 

31,696

 

Amortization of intangible assets

 

5,816

 

5,210

 

10,849

 

11,919

 

Total cost of revenue

 

63,692

 

55,417

 

125,002

 

113,792

 

Gross margin

 

260,861

 

237,511

 

515,016

 

479,346

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

95,275

 

91,956

 

187,789

 

187,840

 

Sales and marketing

 

82,887

 

79,012

 

160,257

 

168,820

 

General and administrative

 

26,171

 

22,551

 

50,012

 

52,228

 

Amortization of intangible assets

 

6,591

 

6,644

 

13,182

 

13,288

 

Total operating expenses

 

210,924

 

200,163

 

411,240

 

422,176

 

Operating income

 

49,937

 

37,348

 

103,776

 

57,170

 

Other income, net

 

151

 

19,668

 

6,481

 

27,602

 

Income before income taxes

 

50,088

 

57,016

 

110,257

 

84,772

 

Provision for income taxes

 

10,701

 

15,751

 

24,425

 

20,150

 

Net income

 

$

39,387

 

$

41,265

 

$

85,832

 

$

64,622

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

$

0.29

 

$

0.60

 

$

0.45

 

Diluted

 

$

0.27

 

$

0.28

 

$

0.58

 

$

0.43

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing per share amounts:

 

 

 

 

 

 

 

 

 

Basic

 

141,844

 

144,370

 

143,926

 

143,527

 

Diluted

 

145,271

 

149,783

 

147,801

 

148,782

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

2



 

SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

85,832

 

$

64,622

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

 

 

 

 

 

Amortization and depreciation

 

50,244

 

52,676

 

Share-based compensation

 

33,486

 

30,565

 

Deferred income taxes

 

3,523

 

10,677

 

Provision for doubtful accounts

 

429

 

(330

)

Net change in deferred gains and losses on cash flow hedges

 

7,495

 

2,990

 

Gain on sale of land

 

 

(4,284

)

Gain on sale of short and long-term investments

 

(1,192

)

(1

)

Net changes in operating assets and liabilities, net of acquired assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(46,982

)

(43,935

)

Prepaid expenses and other current assets

 

(10,300

)

(11,272

)

Other assets

 

26

 

487

 

Accounts payable and accrued liabilities

 

(69,502

)

(59,642

)

Accrued income taxes

 

(2,873

)

(4,592

)

Deferred revenue

 

(67,309

)

107,196

 

Deferred compensation and other liabilities

 

980

 

(926

)

Net cash (used in) provided by operating activities

 

(16,143

)

144,231

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Proceeds from sales and maturities of short-term investments

 

419,181

 

113,351

 

Purchases of short-term investments

 

(253,699

)

(178,782

)

Purchases of long-term investments

 

(6,694

)

 

Sales of long-term investments

 

77

 

 

Purchase of property and equipment

 

(19,498

)

(24,520

)

Proceeds from sale of land

 

 

26,298

 

Capitalization of software development costs

 

(1,408

)

(1,592

)

Net cash provided by (used in) investing activities

 

137,959

 

(65,245

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Payments on lease obligations

 

(1,452

)

 

Issuances of common stock

 

36,949

 

130,240

 

Purchases of treasury stock

 

(170,052

)

(81,394

)

Net cash (used in) provided by financing activities

 

(134,555

)

48,846

 

Effect of exchange rate changes on cash and cash equivalents

 

8,301

 

2,483

 

Net (decrease) increase in cash and cash equivalents

 

(4,438

)

130,315

 

Cash and cash equivalents, beginning of period

 

579,327

 

330,759

 

Cash and cash equivalents, end of period

 

$

574,889

 

$

461,074

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3



 

SYNOPSYS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1.  Description of Business

 

Synopsys, Inc. (Synopsys or the Company) is a world leader in electronic design automation (EDA), supplying the global electronics market with the software, intellectual property (IP) and services used in semiconductor design and manufacturing. The Company delivers technology-leading semiconductor design and verification platforms and integrated circuit (IC) manufacturing products to the global electronics market, enabling the development and production of complex systems-on-chips (SoCs). In addition, the Company provides: (1) IP and design services to simplify the design process and accelerate time-to-market for our customers; and (2) software and services that help customers prepare and optimize their designs for manufacturing.

 

Note 2.  Summary of Significant Accounting Policies

 

The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the Commission). Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP).  In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its financial position, results of operations and cash flows.  The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year.  These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys’ Annual Report on Form 10-K for the fiscal year ended October 31, 2007 on file with the Commission.

 

To prepare financial statements in conformity with GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes.  Actual results could differ from these estimates and may result in material effects on the Company’s operating results and financial position.  There have been no significant changes in accounting policies since the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2007, other than the impact of the adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) which is disclosed in Note 12 Taxes.

 

Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

 

Fiscal Year End.  The Company has adopted a fiscal year ending on the Saturday nearest to October 31. The Company’s second fiscal quarter ended on May 3, 2008 and May 5, 2007.  Fiscal 2008 is a 52-week fiscal year and as a result, the three and six months ended April 30, 2008 had 13 weeks and 26 weeks, respectively.  Fiscal 2007 was a 53-week year and the three and six months ended April 30, 2007 had 13 weeks and 27 weeks, respectively. For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes refer to the applicable calendar month end.

 

Note 3.  Share-based Compensation

 

         Accounting for Share-based Compensation

 

The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options and awards under the employee stock purchase plans in accordance with Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), Share-Based Payment, (SFAS123 (R)). The Black-Scholes option-pricing model incorporates various subjective assumptions including expected volatility, expected term and interest rates. The expected volatility for both stock options and the employee stock purchase plans (ESPP) is estimated by a combination of implied volatility for publicly traded options of the Company’s stock with a term of six months or longer and the historical stock price volatility over the estimated expected term of the Company’s share-based awards. The expected term of the Company’s share-based awards is based on historical experience.

 

4



 

The assumptions used to estimate the fair value of stock options granted and employee stock purchase rights granted under the Company’s stock option plans and ESPP for the three and six months ended April 30, 2008 and 2007 are as follows:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Options

 

 

 

 

 

 

 

 

 

Volatility

 

32.81% - 34.61%

 

30.27% - 30.77%

 

32.81% - 34.61%

 

30.27% - 32.11%

 

Expected term (years)

 

4.5

 

4.3

 

4.5

 

4.3

 

Risk-free interest rate

 

2.40% - 2.85%

 

4.47% - 4.62%

 

2.40% - 3.55%

 

4.35% - 4.73%

 

Expected dividend yield

 

0%

 

0%

 

0%

 

0%

 

Weighted average grant date fair value

 

$7.77

 

$8.50

 

$8.26

 

$8.57

 

 

 

 

 

 

 

 

 

 

 

ESPP

 

 

 

 

 

 

 

 

 

Volatility

 

19.61% - 32.06%

 

19.61% - 44.85%

 

19.61% - 32.06%

 

19.61% - 44.85%

 

Expected term (years)

 

0.5 - 2.0

 

0.5 - 2.0

 

0.5 - 2.0

 

0.5 - 2.0

 

Risk-free interest rate

 

1.62% - 5.09%

 

3.58% - 5.09%

 

1.62% - 5.09%

 

3.58% - 5.09%

 

Expected dividend yield

 

0%

 

0%

 

0%

 

0%

 

Weighted average grant date fair value

 

$5.93

 

$6.43

 

$5.93

 

$6.43

 

 

The Company also granted restricted stock units as part of the Company’s new hire and annual incentive compensation program starting in fiscal 2007.  Restricted stock units are valued based on the closing price of the Company’s common stock on the grant date.  In general, restricted stock units vest over three to four years and are subject to the employees’ continuing service to the Company.  During the three and six months ended April 30, 2008, the weighted average grant date fair values were $24.22 and $27.07 per share, respectively.  During the three and six months ended April 30, 2007, the weighted average grant date fair values were $27.01 and $26.85 per share, respectively.

 

As of April 30, 2008, there was $96.6 million of unamortized share-based compensation expense which is expected to be amortized over a weighted-average period of approximately 3.6 years. The intrinsic values of options exercised during the three and six months ended April 30, 2008 were $3.6 million and $8.7 million, respectively. The intrinsic values of options exercised during the three and six months ended April 30, 2007 were $14.9 million and $47.6 million, respectively.

 

The compensation cost recognized in the unaudited condensed consolidated statement of operations for these share-based compensation arrangements was as follows:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

(in thousands)

 

2008

 

2007

 

2008

 

2007

 

Cost of license

 

$

2,296

 

$

1,621

 

$

3,624

 

$

3,473

 

Cost of maintenance and service

 

810

 

572

 

2,152

 

1,353

 

Research and development expense

 

7,444

 

5,875

 

13,863

 

10,602

 

Sales and marketing expense

 

4,351

 

3,645

 

8,051

 

9,311

 

General and administrative expense

 

2,940

 

2,636

 

5,796

 

5,826

 

Share-based compensation expense before taxes

 

17,841

 

14,349

 

33,486

 

30,565

 

Income tax benefit

 

(4,184)

 

(3,428)

 

(7,852)

 

(7,323)

 

Share-based compensation expense after taxes

 

$

13,657

 

$

10,921

 

$

25,634

 

$

23,242

 

 

Note 4.  Stock Repurchase Program

 

The Company is authorized to purchase up to $500.0 million of its common stock under a stock repurchase program originally established by the Company’s Board of Directors (the Board) in December 2004.  The Company repurchases shares to offset dilution caused by ongoing stock issuances from existing plans for equity compensation awards, acquisitions, and when management believes it is a good use of cash.  Repurchases are transacted in accordance with Rule 10b-18 under the Securities Exchange Act of 1934 (Exchange Act) through open market purchases, plans executed under Rule 10b5-1 under the Exchange Act and structured transactions.

 

5



 

During the three and six months ended April 30, 2008, the Company purchased 3.8 million shares at an average price of $23.06 per share, and 7.2 million shares at an average price of $23.64 per share, respectively. During the three and six months ended April 30, 2007, the Company purchased 2.4 million shares at an average price of $26.38 per share, and 3.1 million shares at an average price of $26.45 per share, respectively.  The aggregate purchase prices were $170.1 million and $81.4 million in the six months ended April 30, 2008 and 2007, respectively. During the three and six months ended April 30, 2008, approximately 1.8 million and 2.5 million shares were reissued, respectively, for employee share-based compensation requirements. During the three and six months ended April 30, 2007, approximately 2.8 million and 7.2 million shares were reissued, respectively, for employee share-based compensation requirements. On March 22, 2007 the Board replenished the stock repurchase program to $500.0 million. As of April 30, 2008, $259.7 million remained available for further purchases under the program.

 

Note 5.          Goodwill and Intangible Assets

 

Goodwill as of April 30, 2008 consisted of the following:

 

 

 

(in thousands)

 

Balance at October 31, 2007

 

$

767,087

 

Adjustments (1)

 

(1,511)

 

Balance at April 30, 2008

 

$

765,576

 

 


(1)          Related to income taxes and payment of a contingent consideration.

 

Intangible assets as of April 30, 2008 consisted of the following:

 

 

 

Gross Assets

 

Accumulated
Amortization

 

Net Assets

 

 

 

(in thousands)

 

Core/developed technology

 

$

112,655

 

$

77,004

 

$

35,651

 

Customer relationships

 

144,950

 

130,865

 

14,085

 

Contract rights intangible

 

8,000

 

6,638

 

1,362

 

Covenants not to compete

 

3,690

 

3,387

 

303

 

Trademarks and tradenames

 

200

 

70

 

130

 

Capitalized software development costs

 

17,879

 

14,632

 

3,247

 

Total (1)

 

$

287,374

 

$

232,596

 

$

54,778

 

 


(1)          Balance does not include intangible assets that were fully amortized prior to fiscal 2008.

 

Intangible assets as of October 31, 2007 consisted of the following:

 

 

 

Gross Assets

 

Accumulated
Amortization

 

Net Assets

 

 

 

(in thousands)

 

Core/developed technology

 

$

112,655

 

$

67,088

 

$

45,567

 

Customer relationships

 

144,950

 

118,471

 

26,479

 

Contract rights intangible

 

8,000

 

5,271

 

2,729

 

Covenants not to compete

 

3,690

 

3,054

 

636

 

Trademarks and tradenames

 

200

 

50

 

150

 

Other intangibles

 

8,383

 

8,383

 

 

Capitalized software development costs

 

16,414

 

13,183

 

3,231

 

Total

 

$

294,292

 

$

215,500

 

$

78,792

 

 

6



 

Total amortization expense related to intangible assets consisted of the following:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Core/developed technology

 

$

5,354

 

$

4,170

 

$

9,916

 

$

9,840

 

Customer relationships

 

6,197

 

6,134

 

12,394

 

12,268

 

Contract rights intangible

 

679

 

517

 

1,367

 

1,033

 

Covenant not to compete

 

166

 

283

 

333

 

565

 

Trademarks and tradenames

 

10

 

10

 

20

 

20

 

Other intangibles

 

 

740

 

 

1,480

 

Capitalized software development costs

 

721

 

832

 

1,449

 

1,642

 

Total

 

$

13,127

 

$

12,686

 

$

25,479

 

$

26,848

 

 

The following table presents the estimated future amortization of intangible assets:

 

 

 

(in thousands)

 

Fiscal Years:

 

 

 

Remainder of fiscal 2008

 

$

15,665

 

2009

 

22,822

 

2010

 

9,847

 

2011

 

3,866

 

2012

 

1,671

 

2013 and thereafter

 

907

 

Total

 

$

54,778

 

 

Note 6.  Accounts Payable and Accrued Liabilities

 

Accounts payable and accrued liabilities consist of:

 

 

 

April 30,
2008

 

October 31,
2007

 

 

 

(in thousands)

 

Accounts payable

 

$

8,506

 

$

11,611

 

Payroll and related benefits

 

130,383

 

192,773

 

Acquisition related costs

 

2,463

 

3,221

 

Other accrued liabilities

 

35,394

 

38,604

 

Total

 

$

176,746

 

$

246,209

 

 

Note 7.  Credit Facility

 

On October 20, 2006, the Company entered into a five-year, $300.0 million senior unsecured revolving credit facility providing for loans to the Company and certain of its foreign subsidiaries.  The amount of the facility may be increased by up to an additional $150.0 million through the fourth year of the facility. The facility contains financial covenants requiring the Company to maintain a minimum leverage ratio and specified levels of cash, as well as other non-financial covenants. The facility terminates on October 20, 2011. Borrowings under the facility bear interest at the greater of the administrative agent’s prime rate or the federal funds rate plus 0.50%; however, the Company has the option to pay interest based on the outstanding amount at Eurodollar rates plus a spread between 0.50% and 0.70% based on a pricing grid tied to a financial covenant. In addition, commitment fees are payable on the facility at rates between 0.125% and 0.175% per year based on a pricing grid tied to a financial covenant. As of April 30, 2008, the Company had no outstanding borrowings under this credit facility and was in compliance with all the covenants.

 

7



 

Note 8.  Comprehensive Income

 

The following table sets forth the components of comprehensive income, net of tax:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Net income

 

$

39,387

 

$

41,265

 

$

85,832

 

$

64,622

 

Change in unrealized (losses) gains on investments, net of tax of $1,275 and $598 for three and six months ended April 30, 2008, respectively, and of ($111) and ($49) for each of the same periods in fiscal 2007, respectively

 

(1,932)

 

165

 

(906)

 

73

 

Deferred gains on cash flow hedges, net of tax of ($758) and ($1,537), for three and six months ended April 30, 2008, respectively, and of ($37) and ($507) for each of the same periods in fiscal 2007, respectively

 

3,854

 

1,648

 

5,958

 

2,483

 

Reclassification adjustment on deferred (gains) losses on cash flow hedges, net of tax of $921 and $1,109, for three and six months ended April 30, 2008, respectively, and of ($64) and ($165) for each of the same periods in fiscal 2007, respectively

 

(3,010)

 

118

 

(4,110)

 

295

 

Foreign currency translation adjustment

 

943

 

3,286

 

(1,431)

 

3,800

 

Total

 

$

39,242

 

$

46,482

 

$

85,343

 

$

71,273

 

 

Note 9.  Net Income per Share

 

In accordance with SFAS No. 128, Earnings per Share (SFAS 128), the Company computes basic income per share by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects the dilution of potential common shares outstanding such as stock options and unvested restricted stock units and awards during the period using the treasury stock method.

 

The table below reconciles the weighted-average common shares used to calculate basic net income per share with the weighted-average common shares used to calculate diluted net income per share.

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

39,387

 

$

41,265

 

$

85,832

 

$

64,622

 

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares for basic net income per share

 

141,844

 

144,370

 

143,926

 

143,527

 

Dilutive effect of common share equivalents from equity-based compensation

 

3,427

 

5,413

 

3,875

 

5,255

 

Weighted-average common shares for diluted net income per share

 

145,271

 

149,783

 

147,801

 

148,782

 

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

$

0.29

 

$

0.60

 

$

0.45

 

Diluted

 

$

0.27

 

$

0.28

 

$

0.58

 

$

0.43

 

 

Diluted net income per share excludes 13.0 million and 6.3 million of anti-dilutive stock options and unvested restricted stock units and awards for the three months ended April 30, 2008 and 2007, respectively; and 9.8 million and 8.9 million of anti-dilutive options and unvested restricted stock units and awards for the six months ended April 30, 2008 and 2007, respectively. While these stock options and unvested restricted stock units and awards were anti-dilutive for the respective periods, they could be dilutive in the future.

 

8



 

Note 10.  Segment Disclosure

 

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131) requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. SFAS 131 reporting is based upon the “management approach,” i.e., how management organizes the Company’s operating segments for which separate financial information is (1) available and (2) evaluated regularly by the Chief Operating Decision Maker (CODM) in deciding how to allocate resources and in assessing performance. Synopsys’ CODMs are the Company’s Chief Executive Officer and Chief Operating Officer.

 

The Company provides software products and consulting services in the electronic design automation software industry. The Company operates in a single segment. In making operating decisions, the CODMs primarily consider consolidated financial information, accompanied by disaggregated information about revenues by geographic region. Specifically, the CODMs consider where individual “seats” or licenses to the Company’s products are used in allocating revenue to particular geographic areas. Revenue is defined as revenues from external customers. Goodwill is not allocated since the Company operates in one reportable operating segment.

 

Revenues related to operations in the United States and other geographic areas were:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

United States

 

$

160,330

 

$

147,839

 

$

321,040

 

$

295,801

 

Europe

 

48,750

 

45,121

 

98,045

 

93,281

 

Japan

 

60,052

 

46,027

 

112,525

 

96,590

 

Asia-Pacific and other

 

55,421

 

53,941

 

108,408

 

107,466

 

Consolidated

 

$

324,553

 

$

292,928

 

$

640,018

 

$

593,138

 

 

Geographic revenue data for multi-region, multi-product transactions reflect internal allocations and is therefore subject to certain assumptions and to the Company’s methodology.

 

One customer accounted for more than ten percent of the Company’s consolidated revenue in the three and six months ended April 30, 2008 and 2007.

 

Note 11.  Other Income, net

 

The following table presents the components of other income, net:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in thousands)

 

Interest income, net

 

$

5,103

 

$

5,897

 

$

11,953

 

$

10,806

 

(Loss) gain on assets related to deferred compensation plan

 

(5,010)

 

1,306

 

(5,503)

 

4,634

 

Other (1)

 

58

 

12,465

 

31

 

12,162

 

Total

 

$

151

 

$

19,668

 

$

6,481

 

$

27,602

 

 


(1)          Includes a litigation settlement of $12.5 million in the three and six months ended April 30, 2007.

 

Note 12.   Taxes

 

Effective Tax Rate

 

The Company estimates its annual effective tax rate at the end of each quarterly period. The Company’s estimate takes into account estimations of annual pre-tax income, the geographic mix of pre-tax income and the Company’s interpretations of tax laws and possible outcomes of audits.

 

9



 

The following table presents the provision for income taxes and the effective tax rates for the three and six months ended April 30, 2008 and 2007:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

$

50,088

 

$

57,016

 

$

110,257

 

$

84,772

 

Provision for income tax

 

$

10,701

 

$

15,751

 

$

24,425

 

$

20,150

 

Effective tax rate

 

21

%

28

%

22

%

24

%

 

The Company’s effective tax rate for the three and six months ended April 30, 2008 is lower than the statutory federal income tax rate of 35% primarily due to the tax impact of non-U.S. operations, which are taxed at lower rates, and research and development credits, partially offset by state taxes and non-deductible share-based compensation recorded under SFAS 123(R). The effective tax rate decreased in the three months and six months ended April 30, 2008, as compared to the same periods in fiscal 2007, primarily due to a favorable change in Irish tax law as well as a state tax audit settlement in the second quarter of 2008.

 

Adoption of FIN 48

 

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). The interpretation contains a two-step approach to recognize and measure uncertain tax positions accounted for in accordance with SFAS 109. The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement.  In May 2007, the FASB issued Staff Position No. FIN 48-1 (FSP FIN 48-1), Definition of Settlement in FASB Interpretation No. 48, which amended FIN 48 to provide guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Under FSP FIN 48-1, a tax position could be effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied.

 

The Company adopted FIN 48 and FSP FIN 48-1 in the first quarter of fiscal 2008 and recognized the cumulative effect of a change in accounting principle by recognizing a decrease in the liability for unrecognized tax benefits of $5.0 million, with a corresponding increase to beginning retained earnings.  The Company also recognized an additional decrease in the liability for unrecognized tax benefits related to employee stock options of $9.7 million of which $7.7 million increased beginning paid-in capital with the remaining $2.0 million off-setting existing deferred tax assets.  The total liability for gross unrecognized tax benefits was $207.3 million on November 1, 2007.  Approximately $124.7 million of the consolidated worldwide liability for unrecognized tax benefits would affect the Company’s effective tax rate if recognized upon resolution of the uncertain tax positions.  The liability for unrecognized tax benefits decreased approximately $7.0 million during the three months ended April 30, 2008.

 

Interest and penalties related to estimated obligations for tax positions taken in the Company’s tax returns are recognized as a component of income tax expense in the unaudited condensed consolidated statements of operations.  As of November 1, 2007, the combined amount of accrued interest and penalties related to tax positions taken on the Company’s tax returns was approximately $10.3 million. The accrued interest and penalties decreased by approximately $3 million during the three months ended April 30, 2008.  Prior to fiscal 2008, the estimated liability for unrecognized tax benefits was presented as a current liability.  FIN 48 requires liabilities for unrecognized tax benefits to be classified based on whether it is expected payment will be made within the next 12 months.  Amounts expected to be paid within the next 12 months are classified as current liabilities and all other amounts are classified as non-current liabilities or offset against a directly related deferred tax asset or income tax receivable.  In addition, the Company has historically recorded state, local and interest liabilities net of the estimated benefit which is expected to be received from deducting such payments on future tax returns (i.e., on a “net” basis).  FIN 48 requires this estimated benefit to be classified as a deferred tax asset instead of a reduction of the overall liability (i.e., on a “gross” basis).

 

The Company files income tax returns in the U.S., including various state and local jurisdictions.  Its subsidiaries file tax returns in various foreign jurisdictions, including Ireland, Hungary, Taiwan and Japan.  The Company remains subject to income tax examinations in the U.S. for fiscal years after 1999, in Hungary and Taiwan for fiscal years after 2005, in Ireland

 

10



 

for fiscal years after 2002 and in Japan for fiscal years after 2004.  See “IRS Examinations,” below for the status of our current federal income tax audits.

 

The timing of the resolution of income tax examinations is highly uncertain as well as the amounts and timing of various tax payments that are part of the settlement process.  This could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities.  The Company believes that before the end of fiscal 2008, it is reasonably possible that its tentative settlement with the Internal Revenue Service (IRS) for its fiscal year 2000 and 2001 tax returns could become final, and that the statute of limitations on certain state and foreign income and withholding taxes will expire.  Given the uncertainty as to ultimate settlement terms, the timing of payment and the impact of such settlements on other uncertain tax positions, the range of the estimated potential decrease in underlying unrecognized tax benefits is between $0 and $50 million.

 

IRS Examinations

 

On June 8, 2005, the Company received a Revenue Agent’s Report in which the IRS proposed to assess a net tax deficiency for fiscal years 2000 and 2001 of approximately $476.8 million, plus interest. This proposed adjustment primarily relates to transfer pricing transactions between Synopsys and a wholly owned foreign subsidiary. The Company strongly believes the proposed IRS adjustment and resulting proposed deficiency are inconsistent with applicable tax laws, and that the Company thus has meritorious defenses to this proposed IRS adjustment.

 

On July 13, 2005, the Company filed a protest to the proposed deficiency with the IRS, which caused the matter to be referred to the Appeals Division of the IRS. In December 2007, the Company reached a tentative settlement with the Appeals Division that would resolve this dispute. The settlement is subject to further review and approval within the government, and may take several months, but the Company believes that settlement is likely. If the settlement becomes final on the tentative terms agreed upon, then the Company has already adequately provided for this matter. Final resolution of this matter could take considerable time or may not be finally approved by the government, in which case, while the Company believes it is still adequately provided for regarding this matter, there is still a possibility that an adverse outcome of the matter could have a material effect on its results of operations and financial condition.

 

In the third quarter of 2006, the IRS started an examination of the Company’s federal income tax returns for the years 2002 through 2004. As of April 30, 2008, no final adjustments have been proposed as a result of this audit which would require an adjustment to the tax provision.

 

Note 13.   Contingencies

 

See also the disclosure in Note 12 above regarding the IRS Revenue Agent’s Report.

 

Other Proceedings

 

The Company is also subject to other routine legal proceedings, as well as demands, claims and threatened litigation, that arise in the normal course of its business. The ultimate outcome of any litigation is uncertain and unfavorable outcomes could have a negative impact on the Company’s financial position and results of operations.

 

Note 14.   Effect of New Accounting Pronouncements

 

 In March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161).  SFAS 161 requires companies with derivative instruments to disclose information on how derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company has not yet determined the impact that SFAS 161 may have on its consolidated financial position, results of operations or cash flows.

 

In May 2008, the FASB issued FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162).  SFAS 162 will identify the source or hierarchy for selecting accounting principles used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles by nongovernmental entities. SFAS 162 is effective for financial statements issued for fiscal years beginning after December 15, 2008.

 

11



 

With the exception of the discussion above, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended April 30, 2008, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended October 31, 2007, that are of significance or potential significance to us.

 

Note 15.   Subsequent Events

 

On May 15, 2008, the Company completed its acquisition of Synplicity, Inc., a Sunnyvale-based company providing field programmable gate array (FPGA) and IC design and verification solutions to communications, military/aerospace, semiconductor, consumer, computer and other electronic applications companies.  In addition, the Company will gain a differentiated hardware-based rapid prototyping portfolio that complements its virtual prototyping business.  Under the terms of the agreement, the Company paid $8.00 per share for all outstanding shares of Synplicity common stock in an all cash transaction for $223.3 million and assumed approximately 1.6 million outstanding employee options and restricted stock units.

 

12



 

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

 

The following discussion of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report. This discussion contains forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in Part II, Item 1A below.

 

Overview

 

Business Environment

 

We generate substantially all of our revenue from customers in the semiconductor and electronics industries. Our customers typically fund purchases of our software and services largely out of their research and development (R&D) budgets and, to a lesser extent, their manufacturing and capital budgets. As a result, our customers’ business outlook and willingness to invest in new and increasingly complex chip designs heavily influence our business.

 

Our customers are increasingly focused on reducing their overall cost of product design, development and manufacturing.   This has affected us in a number of ways.  First, some customers have reduced their EDA expenditures by decreasing their level of EDA tool purchases, using older generations of EDA products or by not renewing maintenance services. Second, some customers are consolidating their EDA purchases with fewer suppliers in order to lower their overall cost of ownership while at the same time meeting new technology challenges. Third, customers are now demanding a broader portfolio of solutions, support and services. Fourth, customers bargain more intensely on all aspects of the contractual arrangement, including pricing, payment terms, post-sale support, remix rights and other terms, which have affected revenues industry-wide.

 

As a result of customers seeking to conserve cash, we shifted our business model in the fourth quarter of 2004 to allow a substantial majority of our customers to pay for licenses over a period of time, rather than upfront at the time of initial purchase.  We also permitted customers to buy pools of technology to address a broad spectrum of their design needs rather than individual point tools, we bundled maintenance with the licenses, and in some cases, enabled customers to access future products.  Arrangements with technology pools, extended payment terms, and rights to unspecified future products generate recurring revenue over a period of time, generally three years, rather than non-recurring upfront license revenue.  Accordingly, most of the revenue we recognize in any particular quarter results from our selling efforts in each of the prior periods during the last three or so years.  This business model reduces our dependence on license arrangements that generate non-recurring upfront license revenue in a particular period and provides us with the ability to resist typical software industry quarter-end pressures and decline business with terms, including pricing terms, that may be less favorable to us.  We continue to target achieving greater than 90% of our license revenue as recurring revenue, which we refer to in our financial statements as time-based license revenue.

 

13



 

Financial Performance for the Three Months Ended April 30, 2008

 

·                                       Total revenue of $324.6 million increased 11% from $292.9 million in the second quarter of fiscal 2007, primarily attributable to bookings of Technology Subscription Licenses (TSLs) in prior periods which increase time-based revenue recognized in later periods.

 

·                                       Time-based license revenue of $278.2 million increased 14% from $243.1 million in the second quarter of fiscal 2007, primarily attributable to bookings of TSLs in prior periods which increase time-based revenue recognized in later periods.

 

·                                       Upfront license revenue of $12.2 million decreased 16% from $14.6 million in the second quarter of fiscal 2007, primarily reflecting fluctuations in customer license type requirements for licenses generating upfront revenue.

 

·                                       We derived approximately 96% of our software license revenue from licenses generating time-based revenues, and 4% from licenses generating upfront revenue in the second quarter of fiscal 2008. This reflects our adherence to our business model.

 

·                                       Maintenance revenue of $15.7 million decreased 10% from $17.5 million in the second quarter of fiscal 2007, primarily attributable to more TSLs for which maintenance is bundled and not charged separately. The decline is also attributable, to a lesser extent, to the non-renewal of maintenance by some of our existing perpetual license customers. Professional service and other revenue of $18.4 million increased 4% from $17.7 million in the second quarter of fiscal 2007, primarily due to the timing and acceptance of services performed under ongoing contracts and continued full utilization of our services capacity.

 

·                                       Net income was $39.4 million compared to $41.3 million in the second quarter of fiscal 2007. The decrease in net income is primarily due to a non-recurring gain from a litigation settlement and sale of land in the second quarter of fiscal 2007, and the timing of certain expenses in fiscal 2008, including an increase in headcount to support our business, offset by revenue growth.

 

·                                       We repurchased approximately 3.8 million shares of our common stock at an average price of $23.06 per share for a total of approximately $87.2 million.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial results under the heading “Result of Operations” below are based on our unaudited condensed consolidated financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles.  In preparing these financial statements, we make assumptions, judgments and estimates that can affect the reported amounts of assets, liabilities, revenues and expenses and net income.  On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances.  Our actual results may differ from these estimates.

 

We describe our revenue recognition and income taxes policies below because these require us to make frequent assumptions, judgments, and estimates. Our remaining critical accounting policies and estimates are discussed in Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2007, filed with the SEC on December 21, 2007.

 

Revenue Recognition.    We recognize revenue from software licenses and related maintenance and service revenue. Software license revenue consists of fees associated with the licensing of our software. Maintenance and service revenue consists of maintenance fees associated with perpetual and term licenses and professional service fees.

 

We have designed and implemented revenue recognition policies in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended.

 

With respect to software licenses, we utilize three license types:

 

·                  Technology Subscription Licenses (TSLs) are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future

 

14



 

technology. We bundle and do not charge separately for post-contract customer support (maintenance) for the term of the license.

 

·                  Term Licenses are also for a finite term, but do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually for the balance of the term. The annual maintenance fee is typically calculated as a percentage of the net license fee.

 

·                  Perpetual Licenses continue as long as the customer renews maintenance plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually.

 

For the three software license types, we recognize revenue as follows:

 

·                  TSLs.  We typically recognize revenue from TSL fees (which include bundled maintenance) ratably over the term of the license period, or as customer installments become due and payable, whichever is later. Revenue attributable to TSLs is reported as “time-based license revenue” in the statement of operations.

 

·                  Term Licenses.  We recognize revenue from term licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the term license fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these term licenses is reported as “upfront license revenue” in the statement of operations. For term licenses in which less than 75% of the term license fee is due within one year from shipment, we recognize revenue as customer installments become due and payable. Such revenue is reported as “time-based license revenue” in the statement of operations.

 

·                  Perpetual Licenses.  We recognize revenue from perpetual licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the perpetual license fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these perpetual licenses is reported as “upfront license revenue” in the statement of operations. For perpetual licenses in which less than 75% of the license fee is payable within one year from shipment, we recognize the revenue as customer installments become due and payable. Revenue attributable to these perpetual licenses is reported as “time-based license revenue” in the statement of operations.

 

In addition, we recognize revenue from maintenance fees associated with term and perpetual licenses ratably over the maintenance period to the extent cash has been received and recognize revenue from professional service and training fees as such services are performed and accepted by the customer. Revenue attributable to maintenance, professional services and training is reported as “maintenance and service revenue” in the statement of operations.

 

Our determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE of fair value for each element to the price charged when such element is sold separately.

 

We have analyzed all of the elements included in our multiple-element software arrangements and have determined that we have sufficient VSOE to allocate revenue to the maintenance components of our perpetual and term license products and to professional services. Accordingly, assuming all other revenue recognition criteria are met, we recognize license revenue from perpetual and term licenses upon delivery using the residual method, we recognize revenue from maintenance ratably over the maintenance term, and we recognize revenue from professional services as the related services are performed and accepted. We recognize revenue from TSLs ratably over the term of the license, assuming all other revenue recognition criteria are met, since there is not sufficient VSOE to allocate the TSL fee between license and maintenance services.

 

We make significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products, we must evaluate whether: (1) persuasive evidence of an arrangement exists, (2) delivery of software or services has occurred, (3) the fee for such software or services is fixed or determinable, and (4) collectibility of the full license or service fee is probable. All four of these criteria must be met in order for us to recognize revenue with respect to a particular arrangement. We apply these revenue recognition criteria as follows:

 

·                  Persuasive Evidence of an Arrangement Exists.  Prior to recognizing revenue on an arrangement, our customary policy is to have a written contract, signed by both the customer and us or a purchase order from those customers that have previously negotiated a standard end-user license arrangement or purchase agreement.

 

15



 

·      Delivery Has Occurred.  We deliver software to our customers physically or electronically. For physical deliveries, the standard transfer terms are typically FOB shipping point. For electronic deliveries, delivery occurs when we provide the customer access codes, or “license keys,” that allow the customer to take immediate possession of the software by downloading it to the customer’s hardware. We generally ship our software products or license keys promptly after acceptance of customer orders. However, a number of factors can affect the timing of product shipments and, as a result, timing of revenue recognition, including the delivery dates requested by customers and our operational capacity to fulfill software license orders at the end of a quarter.

 

·      The Fee is Fixed or Determinable.  Our determination that an arrangement fee is fixed or determinable depends principally on the arrangement’s payment terms. Our standard payment terms for perpetual and term licenses require 75% or more of the arrangement fee to be paid within one year. If the arrangement includes these terms, we regard the fee as fixed or determinable, and recognize all license revenue under the arrangement in full upon delivery (assuming all other revenue recognition criteria are met). If the arrangement does not include these terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable. In the case of a TSL, we recognize revenue ratably even if the fee is fixed or determinable, due to the fact that VSOE for maintenance services does not exist for a TSL and due to revenue recognition criteria relating to arrangements that include rights to exchange products or receive unspecified future technology.

 

·      Collectibility is Probable.  We judge collectibility of the arrangement fees on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers with whom we have a history of successful collection. For a new customer, or when an existing customer substantially expands its commitments to us, we evaluate the customer’s financial position and ability to pay and typically assign a credit limit based on that review. We increase the credit limit only after we have established a successful collection history with the customer. If we determine at any time that collectibility is not probable under a particular arrangement based upon our credit review process or the customer’s payment history, we recognize revenue under that arrangement as customer payments are actually received.

 

Income Taxes.     We calculate our current and deferred tax provisions in accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). Our estimates and assumptions used in such provisions may differ from the actual results as reflected in our income tax returns and we record the required adjustments when they are identified and resolved.

 

We recognize deferred tax assets and liabilities for the temporary differences between the book and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. In evaluating our ability to utilize our deferred tax assets, we consider all available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income on a jurisdiction by jurisdiction basis, as well as feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. We believe that the net deferred tax assets of approximately $293 million that are recorded on our balance sheet will ultimately be realized. However, if we determine in the future that it is more likely than not we will not be able to realize a portion or the full amount of deferred tax assets, we would record an adjustment to the deferred tax asset valuation allowance as a charge to earnings in the period such determination is made.

 

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (FIN 48) and FASB Staff Position No. 48-1 (FSP FIN 48-1) in the first quarter of fiscal 2008.  The interpretation contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109.  The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. In May 2007, the FASB issued FSP FIN 48-1 which amended FIN 48 to provide guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Under FSP FIN 48-1, a tax position could be effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied.

 

Included in our net deferred tax assets are federal foreign tax credits of approximately $65 million, of which approximately $60 million will expire from fiscal 2013 through 2017.  Foreign tax credits can only be carried forward ten years, unlike net operating loss and federal research credit carryforwards that have a twenty year carryforward period. Our

 

16



 

ability to utilize foreign tax credits is dependent upon having sufficient foreign source income during the carryforward period. Our ability to maintain the deferred tax credit requires significant judgment in forecasting our future foreign source income.

 

We have capital loss carryforwards of approximately $17.8 million resulting in a $7.1 million deferred tax asset which will expire in fiscal years 2010 through 2013 if not utilized to offset capital gain net income.  Federal capital losses can only be carried forward five years.  We have provided a valuation allowance on the tax benefit of such losses to the extent they are not expected to be used to offset capital gain net income.

 

We have not provided taxes for undistributed earnings of our foreign subsidiaries (except for certain acquired subsidiaries that we plan to liquidate or dissolve) because we plan to reinvest such earnings indefinitely outside the United States. If the cumulative foreign earnings exceed the amount we intend to reinvest in foreign countries in the future, we would provide for taxes on such excess amount.

 

In addition, the calculation of tax liabilities involves the inherent uncertainty associated with the application of complex tax laws. We are also subject to examination by various taxing authorities. We believe we have adequately provided in our financial statements for potential additional taxes. If we ultimately determine that payment of these amounts is unnecessary, we would reverse the liability and recognize the tax benefit in the period in which we determine that the liability is no longer necessary. If an ultimate tax assessment exceeds our estimate of tax liabilities, we would record an additional charge to earnings. See Part II, Item 1 Legal Proceedings, Part II, Item 1A. Risk Factors — We have received a Revenue Agent’s Report from the Internal Revenue Service claiming a significant increase in our U.S. taxable income.  An adverse outcome could have a material effect on our results of operations and financial condition, below, and Note 12 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of a Revenue Agent’s Report from the Internal Revenue Service (IRS) we received in June 2005 asserting a very large net increase to our U.S. tax arising from the audit of fiscal years 2000 and 2001.

 

Results of Operations

 

Every seven years we have one extra week in our fiscal year that occurs in our first quarter.  The first three months of fiscal 2007 contained that extra week and accordingly this year’s first three months did not include the additional week. The extra week in the first quarter of fiscal 2007 attributed to approximately $18.7 million of additional revenues related primarily to time-based licenses and approximately $17.2 millon of additional expenses as discussed in cost of revenue and operating expenses below.

 

Revenue Background

 

We generate our revenue from the sale of software licenses, maintenance and professional services. Under current accounting rules and policies, we recognize revenue from orders we receive for software licenses and services at varying times. In most instances, we recognize revenue on a TSL software license order over the license term and on a term or perpetual software license order in the quarter in which the license is shipped. Substantially all of our current time-based licenses are TSLs with an average license term of approximately three years. Maintenance orders normally bring in revenue ratably over the maintenance period (normally one year). Professional service orders generally turn into revenue upon completion and customer acceptance of contractually agreed milestones. A more complete description of our revenue recognition policy can be found above under Critical Accounting Policies and Estimates.

 

Our revenue in any fiscal quarter is equal to the sum of our time-based license, upfront license, maintenance and professional service revenue for the period. We derive time-based license revenue in any quarter largely from TSL orders received and delivered in prior quarters. We derive upfront license revenue directly from term and perpetual license orders mostly booked and shipped during the quarter. We derive maintenance revenue in any quarter largely from maintenance orders received in prior quarters since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional service revenue primarily from orders received in prior quarters, since we recognize revenue from professional services when those services are delivered and accepted, not when they are booked.

 

Our license revenue is sensitive to the mix of TSLs and perpetual or term licenses delivered during a reporting period. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL shipped on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the twelve succeeding quarters. Conversely, perpetual licenses and term licenses with greater than 75% of the license fee due within one year from shipment typically generate current quarter revenue but no future revenue (e.g., a $120,000 order for a perpetual license generates $120,000 in revenue in the quarter the product is shipped, but no future revenue).

 

17



 

Total Revenue

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

324.6

 

$

292.9

 

$

31.7

 

11

%

Six months ended

 

$

640.0

 

$

593.1

 

$

46.9

 

8

%

 

Time-Based License Revenue

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

278.2

 

$

243.1

 

$

35.1

 

14

%

Percentage of total revenue

 

86

%

83

%

 

 

 

 

Six months ended

 

$

546.1

 

$

494.7

 

$

51.4

 

10

%

Percentage of total revenue

 

85

%

83

%

 

 

 

 

 

The increase in total revenue and time-based license revenue for the three and six months ended April 30, 2008 compared to the same periods of fiscal 2007 was primarily due to prior period bookings leading to increased current period time-based license revenue.  For the six months ended April 30, 2008, the increase in time-based license revenue was partially offset by the first quarter of fiscal 2008 having one less week of revenues of approximately $17.2 million compared to the same period in fiscal 2007.

 

Upfront License Revenue

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

12.2

 

$

14.6

 

$

(2.4

)

(16

)%

Percentage of total revenue

 

4

%

5

%

 

 

 

 

Six months ended

 

$

24.7

 

$

28.1

 

$

(3.4

)

(12

)%

Percentage of total revenue

 

4

%

5

%

 

 

 

 

 

The upfront license revenue decreased in the three and six months ended April 30, 2008 compared with the same periods of fiscal 2007 reflecting normal fluctuations in customer license requirements which can drive the amount of upfront orders in a particular quarter.

 

Maintenance and Services Revenue

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

 

 

 

 

 

 

 

 

Maintenance revenue

 

$

15.7

 

$

17.5

 

$

(1.8

)

(10

)%

Professional services and other revenue

 

18.4

 

17.7

 

0.7

 

4

%

Total maintenance and services revenue

 

$

34.1

 

$

35.2

 

$

(1.1

)

(3

)%

Percentage of total revenue

 

11

%

12

%

 

 

 

 

Six months ended

 

 

 

 

 

 

 

 

 

Maintenance revenue

 

$

32.1

 

$

37.8

 

$

(5.7

)

(15

)%

Professional services and other revenue

 

37.1

 

32.5

 

4.6

 

14

%

Total maintenance and services revenue

 

$

69.2

 

$

70.3

 

$

(1.1

)

(2

)%

Percentage of total revenue

 

11

%

12

%

 

 

 

 

 

Our maintenance revenue in the three and six months ended April 30, 2008 compared with the same periods in fiscal 2007 has declined primarily due to (1) our completed shift towards TSLs, which include maintenance with the license fee and

 

18



 

thus generate no separately recognized maintenance revenue,  (2)  the first quarter of fiscal 2008 having one less week of revenues for approximately $1.5 million compared to the same period in fiscal 2007, and (3) non-renewal of maintenance by certain customers on perpetual or other upfront licenses. Some customers may choose in the future not to renew maintenance on upfront licenses for economic or other factors, adversely affecting future maintenance revenue.

 

Professional services and other revenue increased in the three and six months ended April 30, 2008 compared to the same periods in fiscal 2007 due principally to timing of customer acceptance of services performed under ongoing contracts.

 

Events Affecting Cost of Revenues and Operating Expenses

 

Functional Allocation of Operating Expenses. We allocate certain human resource programs, information technology and facility expenses among our functional income statement categories based on headcount within each functional area. Annually, or upon a significant change in headcount (such as a workforce reduction, realignment or acquisition) or other factors, management reviews the allocation methodology and the expenses included in the allocation pool.

 

Cost of Revenue

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

 

 

 

 

 

 

 

 

Cost of license revenue

 

$

41.7

 

$

34.7

 

$

7.0

 

20

%

Cost of maintenance and service revenue

 

16.2

 

15.5

 

0.7

 

5

%

Amortization of intangible assets

 

5.8

 

5.2

 

0.6

 

12

%

Total

 

$

63.7

 

$

55.4

 

$

8.3

 

15

%

Percentage of total revenue

 

20

%

19

%

 

 

 

 

Six months ended

 

 

 

 

 

 

 

 

 

Cost of license revenue

 

$

82.1

 

$

70.2

 

$

11.9

 

17

%

Cost of maintenance and service revenue

 

32.1

 

31.7

 

0.4

 

1

%

Amortization of intangible assets

 

10.8

 

11.9

 

(1.1

)

(9

)%

Total

 

$

125.0

 

$

113.8

 

$

11.2

 

10

%

Percentage of total revenue

 

20

%

19

%

 

 

 

 

 

We divide cost of revenue into three categories: cost of license revenue, cost of maintenance and service revenue, and amortization of intangible assets. Expenses directly associated with providing consulting and training are allocated between cost of license revenue and cost of maintenance and service revenue based on license and service revenue reported.

 

Cost of license revenue.  Cost of license revenue includes costs associated with the sale and licensing of our software products. Additionally, cost of license revenue also includes allocated costs of license delivery, such as employee salaries and benefits related to software delivery, software production costs, product packaging, amortization of capitalized software development costs, documentation and royalties to third party vendors.

 

Cost of maintenance and service revenue.  Cost of maintenance and service revenue includes employee salary and benefits for consulting professionals and associated costs to maintain the infrastructure necessary to operate our services and training organization. Further, cost of maintenance and service revenue also includes allocated costs which provide post customer contract services, such as employee salary and benefits related to customer services, such as hotline and on-site support, production services and documentation of maintenance updates.

 

Amortization of intangible assets.  Amortization of intangible assets, which is amortized to cost of revenue and operating expenses, includes the amortization of the contract rights associated with certain executory contracts and the amortization of core/developed technology, trademarks, tradenames, customer relationships, covenants not to compete and other intangibles related to acquisitions completed in prior years.

 

The increase in cost of revenue for the three months ended April 30, 2008 compared with the same period in fiscal 2007, is primarily due to (1) an increase of $6.2 million in personnel related costs as a result of head count increases to support our revenue growth, and (2) an increase of $1.5 million in functionally allocated expenses.

 

19



 

The increase in cost of revenue for the six months ended April 30, 2008 was primarily due to (1) an increase of $12.3 million in personnel related costs as a result of headcount increases, and (2) an increase of $3.3 million in functionally allocated expenses compared to the same period in fiscal 2007.  The increase was partially offset by one less week of costs of approximately $3.6 million in the first quarter of fiscal 2008 compared with the same period in fiscal 2007.

 

Operating Expenses

 

Research and Development

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

95.3

 

$

92.0

 

$

3.3

 

4

%

Percentage of total revenue

 

29

%

31

%

 

 

 

 

Six months ended

 

$

187.8

 

$

187.8

 

$

 

%

Percentage of total revenue

 

29

%

32

%

 

 

 

 

 

For the three months ended April 30, 2008, the increase was primarily due to an increase of $2.9 million in personnel related costs and $1.7 million in functionally allocated expenses compared to the same period in fiscal 2007.  The increase in personnel related costs was partially offset by the absence of a $1.6 million earnout/retention bonus in fiscal 2008 related to a prior acquisition.  This earnout/retention bonus was fully achieved by the end of fiscal 2007.

 

For the six months ended April 30, 2008, research and development costs in absolute dollars were flat compared with the same period in fiscal 2007. Excluding the one extra week of expenses incurred in the first six months of fiscal 2007, research and development costs increased by approximately $6.6 million.  The increase was primarily due to an increase of $6.2 million in employee personnel related costs as a result of headcount increases partially offset by the absence of a $3.1 million earnout/retention bonus related to the prior year acquisition mentioned above, as well as an increase of $3.3 million in functionally allocated expenses compared to the same period in fiscal 2007.

 

Sales and Marketing

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

82.9

 

$

79.0

 

$

3.9

 

5

%

Percentage of total revenue

 

26

%

27

%

 

 

 

 

Six months ended

 

$

160.3

 

$

168.8

 

$

(8.5

)

(5

)%

Percentage of total revenue

 

25

%

28

%

 

 

 

 

 

For the three months ended April 30, 2008, the increase was primarily due to an increase of $4.2 million in variable compensation as a result of higher shipments compared to the same period in fiscal 2007.  The increase was partially offset by the decrease in other miscellaneous marketing expenses.

 

For the six months ended April 30, 2008, the decrease was primarily due to (1)  a decrease of $3.5 million in sales and marketing personnel related costs as a result of headcount reductions, and (2) one less week of expenses of approximately $5.4 million in the first quarter of fiscal 2008 compared to the same period in fiscal 2007.

 

General and Administrative

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

$

26.2

 

$

22.6

 

$

3.6

 

16

%

Percentage of total revenue

 

8

%

8

%

 

 

 

 

Six months ended

 

$

50.0

 

$

52.2

 

$

(2.2

)

(4

)%

Percentage of total revenue

 

8

%

9

%

 

 

 

 

 

20



 

For the three months ended April 30, 2008, the increase was primarily due to a gain of $4.3 million net of related expenses for a land sale completed during the same period in fiscal 2007 and recorded in this line.

 

For the six months ended April 30, 2008, the decrease was primarily due to a decrease of $7.1 million in legal expenses primarily related to litigation and one less week of expenses of approximately $1.5 million in the first quarter of fiscal 2008 compared to the same period in fiscal 2007.  The decrease was offset by (1) $1.2 million increase in other professional services such as tax and audit matters, (2) an increase in communication expenses of $2.3 million and (3) $4.3 million gain, net of related expenses for a land sale completed during the same period in fiscal 2007 and recorded in this line.

 

Amortization of Intangible Assets

 

Amortization of intangible assets includes the amortization of the contract rights associated with certain executory contracts and the amortization of core/developed technology, trademarks, tradenames, customer relationships, covenants not to compete and other intangibles related to acquisitions completed in prior years and in the three months ended April 30, 2008.  Amortization expense is included in the unaudited condensed consolidated statements of operations as follows:

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

 

 

 

 

 

 

 

 

Included in cost of revenue

 

$

5.8

 

$

5.2

 

$

0.6

 

12

%

Included in operating expenses

 

6.6

 

6.6

 

 

%

Total

 

$

12.4

 

$

11.8

 

$

0.6

 

5

%

Percentage of total revenue

 

4

%

4

%

 

 

 

 

Six months ended

 

 

 

 

 

 

 

 

 

Included in cost of revenue

 

$

10.8

 

$

11.9

 

$

(1.1

)

(9

)%

Included in operating expenses

 

13.2

 

13.3

 

(0.1

)

(1

)%

Total

 

$

24.0

 

$

25.2

 

$

(1.2

)

(5

)%

Percentage of total revenue

 

4

%

4

%

 

 

 

 

 

For the six months ended April 30, 2008, the decrease was due to certain intangible assets acquired in prior years being fully amortized.  See Note 5 to Notes to Unaudited Condensed Consolidated Financial Statements for a schedule of future amortization amounts.

 

Other Income, net

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Three months ended

 

 

 

 

 

 

 

 

 

Interest income, net

 

$

5.1

 

$

5.9

 

$

(0.8

)

(14

)%

(Loss) gain on assets related to executive deferred compensation plan

 

(5.0

)

1.3

 

(6.3

)

(485

)%

Other

 

0.1

 

12.5

 

(12.4

)

(99

)%

Total

 

$

0.2

 

$

19.7

 

$

(19.5

)

(99

)%

Six months ended

 

 

 

 

 

 

 

 

 

Interest income, net

 

$

12.0

 

$

10.8

 

$

1.2

 

11

%

(Loss) gain on assets related to executive deferred compensation plan

 

(5.5

)

4.6

 

(10.1

)

(220

)%

Other

 

 

12.2

 

(12.2

)

(100

)%

Total

 

$

6.5

 

$

27.6

 

$

(21.1

)

(76

)%

 

Other income, net decreased $19.5 million and $21.1 million, respectively, in the three and six months ended April 30, 2008, compared to the same periods in fiscal 2007 primarily due to a $12.5 million litigation settlement payment from Magma Design Automation, Inc. and the fair market value fluctuations of investments in our deferred compensation plan.

 

21



 

Income Tax Rate

 

Effective Tax Rate

 

We estimate our annual effective tax rate at the end of each quarterly period. Our estimate takes into account estimations of annual pre-tax income (loss), the geographic mix of pre-tax income (loss) and our interpretations of tax laws and possible outcomes of audits.

 

The following table presents the provision for income taxes and the effective tax rates for the three and six months ended April 30, 2008 and 2007:

 

 

 

Three Months Ended
April 30,

 

Six Months Ended
April 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

$

50.1

 

$

57.0

 

$

110.3

 

$

84.8

 

Provision for income tax

 

$

10.7

 

$

15.8

 

$

24.4

 

$

20.2

 

Effective tax rate

 

21

%

28

%

22

%

24

%

 

Our effective tax rate for the three and six months ended April 30, 2008 is lower than the statutory federal income tax rate of 35% primarily due to the tax impact of non-U.S. operations, which are taxed at lower rates, and research and development credits, partially offset by state taxes and non-deductible share-based compensation recorded under SFAS 123(R). The effective tax rate decreased in the three months and six months ended April 30, 2008, as compared to the same periods in fiscal 2007, primarily due to a favorable change in Irish tax law as well as a state tax audit settlement in the second quarter of 2008.

 

Adoption of FIN 48

 

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). The interpretation contains a two-step approach to recognize and measure uncertain tax positions accounted for in accordance with SFAS 109. The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement.  In May 2007, the FASB issued FSP FIN 48-1, which amended FIN 48 to provide guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Under FSP FIN 48-1, a tax position could be effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied.

 

We adopted FIN 48 and FSP FIN 48-1 in the first quarter of fiscal 2008 and recognized the cumulative effect of a change in accounting principle by recognizing a decrease in the liability for unrecognized tax benefits of $5.0 million, with a corresponding increase to beginning retained earnings.  We also recognized an additional decrease in the liability for unrecognized tax benefits related to employee stock options of $9.7 million of which $7.7 million increased beginning paid-in capital with the remaining $2.0 million off-setting existing deferred tax assets.  The total liability for gross unrecognized tax benefits was $207.3 million on November 1, 2007.  Approximately $124.7 million of the consolidated worldwide liability for unrecognized tax benefits would affect our effective tax rate if recognized upon resolution of the uncertain tax positions.  The liability for unrecognized tax benefits decreased approximately $7.0 million during the three months ended April 30, 2008.

 

Interest and penalties related to estimated obligations for tax positions taken in our tax returns are recognized as a component of income tax expense in the unaudited condensed consolidated statements of operations.  As of November 1, 2007, the combined amount of accrued interest and penalties related to tax positions taken on our tax returns was approximately $10.3 million. The accrued interest and penalties decreased by approximately $3 million during the three months ended April 30, 2008, due to a state tax audit settlement. Prior to fiscal 2008, we presented our estimated liability for unrecognized tax benefits as a current liability.  FIN 48 requires liabilities for unrecognized tax benefits to be classified based on whether it is expected payment will be made within the next 12 months.  Amounts expected to be paid within the next 12 months are classified as current liabilities and all other amounts are classified as non-current liabilities or offset against a directly related deferred tax asset or income tax receivable.  In addition, we have historically recorded state, local and interest liabilities net of the estimated benefit we expect to receive from deducting such payments on future tax returns (i.e., on a

 

22



 

“net” basis).  FIN 48 requires this estimated benefit to be classified as a deferred tax asset instead of a reduction of the overall liability (i.e., on a “gross” basis).

 

We file income tax returns in the U.S., including various state and local jurisdictions.  Our subsidiaries file tax returns in various foreign jurisdictions, including Ireland, Hungary, Taiwan and Japan.  We remain subject to income tax examinations in the U.S. for fiscal years after 1999, in Hungary and Taiwan for fiscal years after 2005, in Ireland for fiscal years after 2002 and in Japan for fiscal years after 2004.  See “IRS Examinations,” below for the status of our current federal income tax audits.

 

The timing of the resolution of income tax examinations is highly uncertain as to the amounts and timing of various tax payments as part of the settlement process.  This could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities.  We believe that before the end of fiscal 2008, it is reasonably possible that our tentative settlement with the IRS for our fiscal year 2000 and 2001 tax returns could become final, and that the statute of limitations on certain state and foreign income and withholding taxes will expire.  Given the uncertainty as to ultimate settlement terms, the timing of payment and the impact of such settlements on other uncertain tax positions, the range of the estimated potential decrease in underlying unrecognized tax benefits is between $0 and $50 million.

 

IRS Examinations

 

On June 8, 2005, we received a Revenue Agent’s Report in which the IRS proposed to assess a net tax deficiency for fiscal years 2000 and 2001 of approximately $476.8 million, plus interest. This proposed adjustment primarily relates to transfer pricing transactions between Synopsys and a wholly-owned foreign subsidiary. We strongly believe the proposed IRS adjustment and resulting proposed deficiency are inconsistent with applicable tax laws, and that we thus have meritorious defenses to this proposed IRS adjustment.

 

In December 2007, we reached a tentative settlement with the Appeals Division that would resolve this dispute. The settlement is subject to further review and approval within the government, which may take several more months, but we believe that settlement is likely. If the settlement becomes final on the tentative terms agreed upon, then we have already adequately provided for this matter. Final resolution of this matter could take considerable time or may not be finally approved by the government, in which case, while we believe we are still adequately provided for regarding this matter, there is still a possibility that an adverse outcome of the matter could have a material effect on our results of operations and financial condition.

 

The IRS is currently examining our federal income tax returns for the years 2002 through 2004. As of April 30, 2008, no final adjustments have been proposed as a result of this audit which would require an adjustment to the tax provision.

 

Liquidity and Capital Resources

 

Our sources of cash, cash equivalents and short-term investments are funds generated from our business operations and funds that may be drawn down under our credit facility.

 

The following sections discuss changes in our balance sheet and cash flows, and other commitments on our liquidity and capital resources during fiscal 2008.

 

Cash and Cash Equivalents and Short-Term Investments

 

 

 

April 30, 2008

 

October 31, 2007

 

Dollar
Change

 

%
Change

 

 

 

(dollars in millions)

 

Cash and cash equivalents

 

$

574.9

 

$

579.3

 

$

(4.4

)

(1

)%

Short-term investments

 

242.6

 

405.1

 

(162.5

)

(40

)%

Total

 

$

817.5

 

$

984.4

 

$

(166.9

)

(17

)%

 

23



 

During the six months ended April 30, 2008, our primary sources and uses of cash consisted of (1) cash used in operating activities of $16.1 million, (2) proceeds from issuance of common stock to employees of $36.9 million, (3) proceeds from sales and maturities of short-term investments of $419.2 million, (4) repurchases of common stock of $170.1 million, (5) purchases of investments of $260.4 million, and (6) purchases of plant and equipment of $19.5 million.

 

Cash Flows

 

 

 

Six Months Ended

 

 

 

 

 

 

 

April 30,

 

Dollar

 

%

 

 

 

2008

 

2007

 

Change

 

Change

 

 

 

(dollars in millions)

 

Cash (used in) provided by operations

 

$

(16.1

)

$

144.2

 

$

(160.3

)

(111

)%

Cash provided (used in) by investing activities

 

$

138.0

 

$

(65.2

)

$

203.2

 

312

%

Cash (used in) provided by financing activities

 

$

(134.6

)

$

48.8

 

$

(183.4

)

(376

)%

 

Cash (used in) provided by operating activities.  Cash used in or provided by operations is dependent primarily upon the payment terms of our license agreements. To be classified as upfront revenue, we require that 75% of a term or perpetual license fee be paid within the first year. Conversely, payment terms for TSLs are generally extended and the license fee is typically paid either quarterly or annually in even increments over the term of the license. Accordingly, we generally receive cash from upfront license revenue much sooner than from time-based license revenue.

 

Cash used in operating activities is a result of a decrease in deferred revenue due to the timing of billings and cash payment from certain customers compared to the same period in fiscal 2007, delivering lower cash inflows during fiscal 2008.

 

Cash provided by (used in) investing activities.  The increase in cash provided by investing activities relates to the sale of marketable securities in anticipation of our May 15, 2008 acquisition of Synplicity, Inc. offset by our capital expenditures to support our information technology infrastructure.

 

Cash (used in) provided by financing activities.  The increase in cash used primarily relates to larger common stock repurchases under our stock repurchase program and a lower number of employee option exercises compared to the same period in fiscal 2007. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements for details of our stock repurchase program.

 

We hold our cash, cash equivalents and short-term investments in the United States and in foreign accounts, primarily in Ireland, Bermuda, Hungary and Japan. As of April 30, 2008, we held an aggregate of $511.8 million in cash, cash equivalents and short-term investments in the United States and an aggregate of $305.7 million in foreign accounts. Funds in foreign accounts are generated from revenue outside North America. At present, such foreign funds are considered to be indefinitely reinvested in foreign countries.

 

We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in the timing of our billings and collections, our operating results, the timing and amount of tax and other liability payments and cash used in any future acquisitions.

 

Accounts Receivable, net

 

April 30, 2008

 

October 31, 2007

 

Dollar Change

 

% Change

 

 

 

(dollars in millions)

 

 

 

$

172.0

 

$

123.9

 

$

48.1

 

39

%

 

Our accounts receivable and Days Sales Outstanding (“DSO”) are primarily driven by our billing and collections activities. Our DSO was 48 days at April 30, 2008 and 36 days at October 31, 2007.  The increase in DSO, along with an increase in accounts receivable balance, primarily relates to increased billings that occurred late in the second quarter with subsequent period payment terms.

 

Net Working Capital.  Working capital is comprised of current assets less current liabilities, as shown on our unaudited condensed consolidated balance sheets. As of April 30, 2008, our net working capital was $507.8 million, compared to $296.5 million as of October 31, 2007. The increase of $211.3 million was primarily due to (1) an increase in accounts receivable of $48.1 million; (2) a reclassification from income taxes payable of $197.3 million to long-term income tax payable upon adoption of FIN 48; (3) a decrease of $69.5 million in accounts payable and accrued liabilities, and (4) a decrease in deferred revenue of $55.2 million. This increase was partially offset by a decrease in cash, cash equivalents and short-term investments of $166.9 million.

 

24



 

Other Commitments—Revolving Credit Facility.  On October 20, 2006, we entered into a five-year, $300.0 million senior unsecured revolving credit facility providing for loans to Synopsys and certain of our foreign subsidiaries. The amount of the facility may be increased by up to an additional $150.0 million through the fourth year of the facility. The facility contains financial covenants requiring us to maintain a minimum leverage ratio and specified levels of cash, as well as other non-financial covenants. The facility terminates on October 20, 2011. Borrowings under the facility bear interest at the greater of the administrative agent’s prime rate or the federal funds rate plus 0.50%; however, we have the option to pay interest based on the outstanding amount at Eurodollar rates plus a spread between 0.50% and 0.70% based on a pricing grid tied to a financial covenant. In addition, commitment fees are payable on the facility at rates between 0.125% and 0.175% per year based on a pricing grid tied to a financial covenant. As of April 30, 2008, we had no outstanding borrowings under this credit facility and were in compliance with all covenants.

 

Other

 

Our cash equivalent and short-term investment portfolio as of April 30, 2008 consists of investment grade municipal bonds, tax-exempt money market mutual funds and taxable money market mutual funds. We follow an established investment policy and set of guidelines to monitor, manage and limit our exposure to interest rate and credit risk.  The policy sets forth credit quality standards and limits our exposure to any one issuer.   As a result of current adverse financial market conditions, some financial instruments, such as structured investment vehicles, sub-prime mortgage-backed securities and collateralized debt obligations, may pose risks arising from liquidity and credit concerns.  As of April 30, 2008, we had no direct holdings in these categories of investments and our exposure to these financial instruments through our indirect holdings in money market mutual funds was less than 1% of total cash, cash equivalents and short-term investments, which we do not consider to be material. As of April 30, 2008, we had no impairment charge associated with our short-term investment portfolio.  While we cannot predict future market conditions or market liquidity, we have taken steps, including regularly reviewing our investments and associated risk profiles, which we believe will allow us to effectively manage the risks of our investment portfolio.

 

On May 15, 2008, we completed our acquisition of Synplicity, Inc. and paid $8.00 per Synplicity share in an all cash transaction for $223.3 million.  See Note 15 of Notes to Unaudited Condensed Consolidated Financial Statements for further information.

 

We believe that our current cash, cash equivalents, short-term investments, cash generated from operations, and available credit under our credit facility will satisfy our business requirements for at least the next twelve months.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our exposure to market risk has not changed materially since October 31, 2007.  The average yield at purchase for our short-term investment portfolio remains approximately the same as of October 31, 2007.  For more information in financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Item 7A Quantitative and Qualitative Disclosure About Market Risk contained in Part II of our Annual Report on Form 10-K for the fiscal year ended October 31, 2007.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a)  Evaluation of Disclosure Controls and Procedures.   As of April 30, 2008 (the Evaluation Date), Synopsys carried out an evaluation under the supervision and with the participation of Synopsys’ management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Synopsys’ disclosure controls and procedures (as such term is defined in Rules 13a-15 (e) and 15d-15 (e) under the Exchange Act). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable, not absolute, assurance of achieving their control objectives. Nonetheless, our Chief Executive Officer and Chief Financial Officer have concluded that, as of April 30, 2008, (1) Synopsys’ disclosure controls and procedures were designed to provide reasonable assurance of achieving their objectives, and (2) Synopsys’ disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports Synopsys files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required, and that such information is accumulated and communicated to Synopsys’ management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding its required disclosure.

 

(b) Changes in Internal Controls.  There were no changes in Synopsys’ internal control over financial reporting during the three months ended April 30, 2008 that have materially affected, or are reasonably likely to materially affect, Synopsys’ internal control over financial reporting.

 

25



 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

IRS Revenue Agent’s Report.   On June 8, 2005, we received a Revenue Agent’s Report in which the IRS proposed to assess a net tax deficiency for fiscal years 2000 and 2001 of approximately $476.8 million, plus interest. This proposed adjustment primarily relates to transfer pricing transactions between Synopsys and a wholly-owned foreign subsidiary. We strongly believe the proposed IRS adjustment and resulting proposed deficiency are inconsistent with applicable tax laws, and that we thus have meritorious defenses to this proposed IRS adjustment.

 

On July 13, 2005, we filed a protest to the proposed deficiency with the IRS, which caused the matter to be referred to the Appeals Division of the IRS. In December 2007, we reached a tentative settlement with the Appeals Division that would resolve this dispute. The settlement is subject to further review and approval within the government, which may take several months, but we believe that settlement is likely. If the settlement becomes final on the tentative terms agreed upon, then we have already adequately provided for this matter. Final resolution of this matter could take considerable time or may not be finally approved by the government, in which case, while we believe we are still adequately provided for regarding this matter, there is still a possibility that an adverse outcome of the matter could have a material effect on our results of operations and financial condition.

 

Other Proceedings. We are also subject to other routine legal proceedings, as well as demands, claims and threatened litigation, that arise in the normal course of our business. The ultimate outcome of any litigation is uncertain and unfavorable outcomes could have a negative impact on our results of operations and financial condition. Regardless of outcome, litigation can have an adverse impact on Synopsys because of the defense costs, diversion of management resources and other factors.

 

ITEM 1A. RISK FACTORS

 

We describe our business risk factors below. This description includes any changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended October 31, 2007.

 

Weakness, budgetary caution or consolidation in the semiconductor and electronics industries may continue to negatively impact our business.

 

In recent years, we believe that EDA industry growth has been adversely affected by many factors, including ongoing efforts by semiconductor companies to control their spending, uncertainty regarding the long-term growth rate of the semiconductor industry, excess EDA tool capacity of some of our customers and increased competition in the EDA industry itself causing pricing pressure on EDA vendors. If these factors persist or additional semiconductor industry growth does not occur (or if we do not benefit from any such increases), our business, operating results and financial condition will be materially and adversely affected.

 

We also believe that, over the long term, growth in EDA spending will continue to depend on growth in semiconductor R&D spending and continued growth in the overall semiconductor market. However, we cannot predict the timing or magnitude of growth in semiconductor revenues, R&D spending or spending on EDA products, nor whether we will benefit from any of these increases should they occur.  In addition, unfavorable general macroeconomic factors may also affect our customers and in turn our business, operating results and financial condition.

 

Competition in the EDA industry may have a material adverse effect on our business and financial results.

 

We compete with other EDA vendors that offer a broad range of products and services, primarily Cadence Design Systems, Inc., Mentor Graphics Corporation and Magma Design Automation, Inc. and with other EDA vendors that offer products focused on one or more discrete phases of the IC design process.  We also compete with customers’ internally developed design tools and capabilities. If we fail to compete effectively, our business will be materially and adversely affected. We compete principally on technology leadership, product quality and features (including ease-of-use), time-to-results, post-sale support, interoperability with our own and other vendors’ products, price and payment terms.

 

Additional competitive challenges include the following:

 

·              Technology in the EDA industry evolves rapidly. Accordingly, we must correctly anticipate and lead critical developments, innovate rapidly and efficiently, improve our existing products, and successfully develop or acquire new products. If we fail to do so, our business will be materially and adversely affected.

 

26



 

·              We believe we are best served by offering products that provide both a high level of integration into a comprehensive platform and a high level of individual product performance. We have invested significant resources into further development of our Galaxy Design Platform, integration of our Discovery Verification Platform and enhancement of its SystemVerilog and other advanced features and development of our Design for Manufacturing and IP portfolios. We can provide no assurance that our customers will find these tool and IP configurations more attractive than our competitors’ offerings or that our efforts to balance the interests of integration versus individual product performance will be successful.

 

·              Price continues to be a competitive factor. We believe that some EDA vendors are increasingly offering discounts, which could be significant. If we are unable to match a competitor’s pricing for a particular solution, we may lose business, which could have a material adverse effect on our financial condition and results of operations, particularly if the customer chooses to consolidate all or a substantial portion of their other EDA purchases with the competitor.

 

·              Payment terms are also an important competitive factor and are aggressively negotiated by our customers.  Payment terms on time-based licenses have generally lengthened over time. Longer payment terms could continue in the future, which would negatively affect our future operating cash flow.

 

·              Potential consolidation of competitors. If any of our competitors consolidate, they may be able to exert even greater competitive pressure by offering a more complete (larger) technology portfolio, a larger support and service capability, or lower prices.

 

·              Entry or expansion could occur. Despite the complexity of the EDA space, entry and expansion into the EDA space by new or existing companies can and does occur, and could make it more difficult to compete successfully.

 

Lack of growth in new IC design starts, industry consolidation and other potentially long-term trends may adversely affect the EDA industry, including demand for our products and services.

 

The increasing complexities of SoCs and ICs, and customers’ concerns about managing cost and risk have also led to the following potentially long-term negative trends:

 

·              The number of IC design starts has remained flat during the last three years. New IC design starts are one of the key drivers of demand for EDA software.

 

·              A number of mergers in the semiconductor and electronics industries have occurred and more are likely. Mergers can reduce the aggregate level of purchases of EDA software and services, and in some cases, increase customers’ bargaining power in negotiations with their suppliers, including Synopsys.

 

·              Due to factors such as increased globalization, cost controls among customers appear to have become more permanent, adversely impacting our customers’ EDA spending.

 

·              Industry changes, plus the cost and complexity of IC design, may be leading some companies in these industries to limit their design activity in general, to focus only on one discrete phase of the design process while outsourcing other aspects of the design, or using Field Programmable Gate Arrays (FPGAs), an alternative chip technology.

 

All of these trends, if sustained, could have a material adverse effect on the EDA industry, including the demand for our products and services, which in turn would materially and adversely affect our financial condition and results of operations.

 

Changes in, or interpretations of, accounting principles could result in unfavorable accounting charges or effects, including changes to our prior financial statements, which could cause our stock price to decline.

 

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting principles. A change in these principles, or in our interpretations of these principles, can have a significant effect on our reported results and may retroactively affect previously reported results.

 

For example, in June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 addresses recognizing and measuring uncertain tax positions. The interpretation contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. The first step is to evaluate the tax position for recognition by determining whether it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement.   Synopsys adopted FIN 48 beginning in the first quarter of fiscal year 2008. Because the determination

 

27



 

of whether a position is “more likely than not” is subject to ongoing changes in the interpretation in the tax law, based on published rulings, court cases and outcomes of various tax audits, we may be required to recognize or adjust a tax position in the period in which such changes occur. In addition, measurement of the amount of benefit which is more than 50% likely of being realized involves a great deal of judgment, and may change based on our experience and new or revised authority.

 

We have received a Revenue Agent’s Report from the Internal Revenue Service claiming a significant increase in our U.S. taxable income. An adverse outcome could have a material effect on our results of operations and financial condition.

 

On June 8, 2005, we received a Revenue Agent’s Report in which the Internal Revenue Service (IRS) proposed to assess a net tax deficiency for fiscal years 2000 and 2001 of approximately $476.8 million, plus interest. This proposed adjustment primarily relates to transfer pricing transactions between Synopsys and a wholly-owned foreign subsidiary. We strongly believe the proposed IRS adjustment and resulting proposed deficiency are inconsistent with applicable tax laws, and that we thus have meritorious defenses to this proposed IRS adjustment. On July 13, 2005, we filed a protest to the proposed deficiency with the IRS, which caused the matter to be referred to the Appeals Division of the IRS. In December 2007, we reached a tentative settlement with the Appeals Division that would resolve this dispute. The settlement is subject to further review and approval within the government, which may take several months, but we believe that settlement is likely. If the settlement becomes final on the tentative terms agreed upon, then we have already adequately provided for this matter. Final resolution of this matter could take considerable time or may not be finally approved by the government, in which case, while we believe we are still adequately provided for regarding this matter, there is still a possibility that an adverse outcome of the matter could have a material effect on our results of operations and financial condition.

 

Unfavorable tax law changes, an unfavorable government review of our tax returns or changes in our geographical earnings mix or forecasts of foreign source income could adversely affect our effective tax rate and our operating results.

 

Our operations are subject to income and transaction taxes in the United States and in multiple foreign jurisdictions. A change in the tax law in the jurisdictions in which we do business, including an increase in tax rates or an adverse change in the treatment of an item of income or expense, could result in a material increase in our tax expense.

 

Our tax filings are subject to review or audit by the Internal Revenue Service and state, local and foreign taxing authorities. We exercise judgment in determining our worldwide provision for income taxes and, in the ordinary course of our business, there may be transactions and calculations where the ultimate tax determination is uncertain. In the third quarter of fiscal year 2006, the IRS started an examination of our federal income tax returns for the fiscal years 2002 through 2004. As of April 30, 2008, the examination is still in progress and no final adjustments have been proposed by the IRS which would require an adjustment to the tax provision. Although we believe our tax estimates are reasonable, we can provide no assurance that any final determination in the audit will not be materially different than the treatment reflected in our historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit, there could be a material adverse effect on our income tax provision and net income in the period or periods for which that determination is made.

 

We have large operations both in the United States and in multiple foreign jurisdictions with a wide range of statutory tax rates. Certain foreign operations are subject to temporary favorable foreign tax rates. Therefore, any changes in our geographical earning mix in various tax jurisdictions and expiration of foreign tax rulings could materially increase our effective tax rate. Furthermore, we maintain deferred tax assets related to federal foreign tax credits and our ability to use these credits is dependent upon having sufficient future foreign source income in the United States. Changes in our forecasts of such future foreign source income could result in an adjustment to the deferred tax asset and a related charge to earnings which could materially affect our financial results.

 

Our revenue and earnings fluctuate, which could cause our financial results to not meet expectations and our stock price to decline.

 

Many factors affect our revenue and earnings, including customer demand, license mix, the timing of revenue recognition on products and services sold and committed expense levels, making it difficult to predict revenue and earnings for any given fiscal period. Accordingly, stockholders should not view our historical results as necessarily indicative of our future performance.

 

From time to time, we provide guidance related to our future financial performance. In addition, financial analysts publish their own expectations of our future financial performance. Because our quarterly revenue and our operating results fluctuate, future financial performance is difficult to predict. Downward adjustments of our guidance or the failure to meet our guidance or the expectations of research analysts would cause the market price of our common stock to decline.

 

28



 

Some of the specific factors that could affect our revenue and earnings in a particular quarter or over several fiscal periods include, but are not limited to:

 

·              We base our operating expenses in part on our expectations for future revenue and generally must commit to expense levels in advance of revenue being recognized. Since only a small portion of our expenses varies with revenue, any revenue shortfall typically causes a direct reduction in net income.

 

·              Our revenue and earnings targets over a number of fiscal periods assume a certain level of orders and a certain mix between upfront and time-based licenses. The amount of orders received and changes in the mix due to factors such as the level of overall license orders, customer demand, customer payment terms and ship dates could have a material adverse effect on our revenue and earnings. For example, if we ship more upfront licenses than expected during any given fiscal period, our revenue and earnings for that period could be above our targets even if orders are below target; conversely, if we ship fewer upfront licenses than expected, our revenue and earnings for that period could fall below our targets even if orders meet or even exceed our target. Similarly, if we receive a lower-than-expected level of time-based license orders during a given period, our revenue in future periods could be negatively affected.

 

·              We may be required to implement a number of cost control measures in order to meet our externally-communicated financial targets, any of which could fail to result in the anticipated cost savings or could adversely affect our business.  For example, we have outsourced certain internal functions that may not realize expected cost savings.

 

·              The market for EDA products is dynamic and depends on a number of factors including consumer demand for our customers’ products, customer R&D and EDA tool budgets, pricing, our competitors’ product offerings and customer design starts. It is difficult to predict in advance the effect of these and other factors on our customers’ demand for our products on a medium or long term basis. As a result, actual future customer purchases could differ materially from our forecasts which, in turn, could cause our actual revenue to be materially different than our publicly-disclosed targets.

 

·              We often amend our contracts with our customers to extend the term or add new products. Although these amendments can provide a longer-term payment stream from the customers, they can also result in a lower amount of revenue being recognized per year than under the original arrangement even if the total value of the extended contract is larger.

 

·              Certain of our upfront and time-based license agreements provide customers the right to re-mix a portion of the software initially subject to the license for other specified Synopsys products. While this practice helps assure the customer’s access to the complete design flow needed to manufacture its product, use of these arrangements could result in reduced revenue compared to licensing the individual tools separately.

 

·              In the past, we have regularly received a significant proportion of our orders for a given quarter in the last one or two weeks of the quarter. The delay of one or more orders, particularly an upfront order, could have a material adverse effect on our revenue and/or earnings for that quarter.

 

·              We rely on a small number of customers for a large portion of our revenue and the loss of one of such customers could have an adverse effect on our subsequent revenue and/or earnings.

 

·              We make significant judgments relating to revenue recognition, specifically determining the existence of proper documentation, establishing that the fee is fixed or determinable, verifying delivery of our software and assessing the creditworthiness of our customers. While we believe our judgments in these areas are reasonable, there can be no assurance that such judgments will not be challenged in the future. In such an event, we could be required to reduce the amount of revenue we have recognized in prior periods, which would have an adverse impact on our reported results of operations for those periods.

 

·              Our customers spend a great deal of time reviewing and testing our products, either alone or against competing products, before making a purchase decision. Accordingly, our customers’ evaluation and purchase cycles may not match our fiscal quarters. Further, sales of our products and services may be delayed if customers delay project approvals or starts because of budgetary constraints or their budget cycles.

 

The failure to meet the semiconductor industry’s demands for advancing EDA technology and continued cost reductions may adversely affect our financial results.

 

29



 

SoC and IC functionality continues to increase while feature widths decrease, substantially increasing the complexity, cost and risk of IC design and manufacturing. To address greater complexity, semiconductor designers and manufacturers demand continuous innovation from EDA suppliers. At the same time, as a general business trend, we believe some customers and potential customers are seeking to buy more products from fewer suppliers and at reduced overall prices in an effort to reduce overall cost and risk. In order to succeed in this environment, we must successfully meet our customers’ technology requirements, while also striving to reduce their overall costs and our own operating costs. Failure to manage these conflicting demands successfully would materially and adversely affect our financial condition and results of operations.

 

Customer payment defaults or related issues could adversely affect our financial condition and results of operations.

 

Our backlog consists principally of customer payment obligations not yet due that are attributable to software we have already delivered. These customer obligations are typically not cancelable, but will not yield the expected revenue and cash flow if the customer defaults or declares bankruptcy and fails to pay amounts owed. In these cases, we will generally take legal action to recover amounts owed. Moreover, existing customers may seek to renegotiate pre-existing contractual commitments due to adverse changes in their own businesses. Though we have not, to date, experienced a material level of defaults, any material payment default by our customers or significant reductions in existing contractual commitments would have a material adverse effect on our financial condition and results of operations.

 

Businesses we have acquired or that we may acquire in the future may not perform as we project.

 

We have acquired a number of companies or their assets in recent years and as part of our efforts to expand our product and services offerings we expect to make additional acquisitions in the future.

 

In addition to direct costs, acquisitions pose a number of risks, including:

 

·              Potential negative impact on our earnings per share;

 

·              Failure of acquired products to achieve projected sales;

 

·              Problems in integrating the acquired products with our products;

 

·              Difficulties in retaining key employees and integrating them into our company;

 

·              Failure to realize expected synergies or cost savings;

 

·              Regulatory delays;

 

·              Drain on management time for acquisition-related activities;

 

·              Assumption of unknown liabilities;

 

·              Additional tax liabilities; and

 

·              Adverse effects on customer buying patterns or relationships.

 

While we review proposed acquisitions carefully and strive to negotiate terms that are favorable to us, we can provide no assurance that any acquisition will positively affect our future performance. Furthermore, if we later determine we cannot use or sell an acquired product or technology, we could be required to write down the goodwill and intangible assets associated with the product or technology; any such write-downs could have a material adverse effect on our results of operations.

 

Conditions of foreign economies, foreign exchange rate fluctuations and the increasingly global nature of our operations could adversely affect our performance.

 

During the first half of fiscal 2008 and full fiscal years of 2007 and 2006, we derived approximately 50%  of our revenue from outside the United States; in the future, we expect our overall orders and revenue targets will continue to depend on substantial contributions from customers outside the United States. Foreign sales are vulnerable to regional or worldwide economic, political and health conditions, including the effects of international political conflict, hostilities and natural disasters. Further, any deterioration of foreign economies or foreign currency exchange rates would adversely affect our performance by reducing the amount of revenue derived from outside the United States.

 

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