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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended October 31, 2008
Or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 0-13442
MENTOR GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)
Oregon | 93-0786033 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
8005 SW Boeckman Road, Wilsonville, Oregon | 97070-7777 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (503) 685-7000
None
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition 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 ¨ Non-accelerated filer ¨ Smaller reporting Company ¨ | ||||||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of shares of common stock, no par value, outstanding as of December 4, 2008: 92,359,849
Table of Contents
Index to Form 10-Q
Page Number | ||||
PART I. FINANCIAL INFORMATION | ||||
Item 1. | Financial Statements (unaudited) | |||
Condensed Consolidated Statements of Operations for the three months ended October 31, 2008 and 2007 | 3 | |||
Condensed Consolidated Statements of Operations for the nine months ended October 31, 2008 and 2007 | 4 | |||
Condensed Consolidated Balance Sheets as of October 31, 2008 and January 31, 2008 | 5 | |||
Condensed Consolidated Statements of Cash Flows for the nine months ended October 31, 2008 and 2007 | 6 | |||
Notes to Unaudited Condensed Consolidated Financial Statements | 7 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 25 | ||
Item 3. | 43 | |||
Item 4. | 45 | |||
PART II. OTHER INFORMATION | ||||
Item 1A. | 46 | |||
Item 6. | 54 | |||
55 |
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PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended October 31, | 2008 | 2007 | ||||||
In thousands, except per share data | ||||||||
Revenues: | ||||||||
System and software | $ | 97,312 | $ | 108,393 | ||||
Service and support | 87,540 | 82,096 | ||||||
Total revenues | 184,852 | 190,489 | ||||||
Cost of revenues: | ||||||||
System and software | 3,566 | 4,706 | ||||||
Service and support | 24,350 | 24,453 | ||||||
Amortization of purchased technology | 3,810 | 2,139 | ||||||
Total cost of revenues | 31,726 | 31,298 | ||||||
Gross margin | 153,126 | 159,191 | ||||||
Operating expenses: | ||||||||
Research and development | 65,146 | 63,706 | ||||||
Marketing and selling | 76,688 | 74,580 | ||||||
General and administration | 24,333 | 24,183 | ||||||
Other general expense, net | 168 | 178 | ||||||
Amortization of intangible assets | 3,129 | 2,704 | ||||||
Special charges | 2,214 | 1,115 | ||||||
In-process research and development | 6,790 | — | ||||||
Total operating expenses | 178,468 | 166,466 | ||||||
Operating loss | (25,342 | ) | (7,275 | ) | ||||
Other income, net | 1,694 | 1,026 | ||||||
Interest expense | (4,270 | ) | (5,053 | ) | ||||
Loss before income tax and minority interest | (27,918 | ) | (11,302 | ) | ||||
Income tax expense (benefit) | 50,369 | (2,506 | ) | |||||
Minority interest in net loss of subsidiary | (43 | ) | — | |||||
Net loss | $ | (78,244 | ) | $ | (8,796 | ) | ||
Net loss per share: | ||||||||
Basic | $ | (0.85 | ) | $ | (0.10 | ) | ||
Diluted | $ | (0.85 | ) | $ | (0.10 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 92,354 | 89,609 | ||||||
Diluted | 92,354 | 89,609 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Condensed Consolidated Statements of Operations
(Unaudited)
Nine Months Ended October 31, | 2008 | 2007 | ||||||
In thousands, except per share data | ||||||||
Revenues: | ||||||||
System and software | $ | 289,985 | $ | 354,162 | ||||
Service and support | 256,478 | 240,750 | ||||||
Total revenues | 546,463 | 594,912 | ||||||
Cost of revenues: | ||||||||
System and software | 13,204 | 16,548 | ||||||
Service and support | 73,722 | 69,703 | ||||||
Amortization of purchased technology | 9,040 | 7,513 | ||||||
Total cost of revenues | 95,966 | 93,764 | ||||||
Gross margin | 450,497 | 501,148 | ||||||
Operating expenses: | ||||||||
Research and development | 193,779 | 187,628 | ||||||
Marketing and selling | 226,135 | 222,279 | ||||||
General and administration | 71,493 | 71,080 | ||||||
Other general income, net | (269 | ) | (38 | ) | ||||
Amortization of intangible assets | 8,099 | 6,361 | ||||||
Special charges | 15,099 | 5,160 | ||||||
In-process research and development | 22,075 | 4,100 | ||||||
Total operating expenses | 536,411 | 496,570 | ||||||
Operating income (loss) | (85,914 | ) | 4,578 | |||||
Other income, net | 4,697 | 3,961 | ||||||
Interest expense | (12,230 | ) | (15,112 | ) | ||||
Loss before income tax and minority interest | (93,447 | ) | (6,573 | ) | ||||
Income tax expense (benefit) | 27,024 | (450 | ) | |||||
Minority interest in net loss of subsidiary | (132 | ) | — | |||||
Net loss | $ | (120,339 | ) | $ | (6,123 | ) | ||
Net loss per share: | ||||||||
Basic | $ | (1.32 | ) | $ | (0.07 | ) | ||
Diluted | $ | (1.32 | ) | $ | (0.07 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 91,484 | 87,456 | ||||||
Diluted | 91,484 | 87,456 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Condensed Consolidated Balance Sheets
(Unaudited)
As of | October 31, 2008 | January 31, 2008 | |||||
In thousands | |||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 77,593 | $ | 117,926 | |||
Short-term investments | 1,997 | 8,289 | |||||
Trade accounts receivable, net of allowance for doubtful accounts of $3,390 as of October 31, 2008 and $4,577 as of January 31, 2008 | 243,999 | 332,641 | |||||
Other receivables | 6,159 | 7,936 | |||||
Inventory | 10,997 | 8,682 | |||||
Prepaid expenses and other | 21,305 | 21,433 | |||||
Deferred income taxes | 10,747 | 9,574 | |||||
Total current assets | 372,797 | 506,481 | |||||
Property, plant, and equipment, net of accumulated depreciation of $220,205 as of October 31, 2008 and $210,743 as of January 31, 2008 | 106,063 | 100,421 | |||||
Term receivables, long-term | 124,791 | 134,059 | |||||
Goodwill | 440,261 | 417,485 | |||||
Intangible assets, net of accumulated amortization of $108,739 as of October 31, 2008 and $93,103 as of January 31, 2008 | 45,774 | 34,396 | |||||
Deferred income taxes | 10,443 | 18,729 | |||||
Other assets | 24,337 | 26,542 | |||||
Total assets | $ | 1,124,466 | $ | 1,238,113 | |||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities: | |||||||
Short-term borrowings | $ | 39,705 | $ | 14,178 | |||
Accounts payable | 10,143 | 23,634 | |||||
Income taxes payable | 18,880 | 6,675 | |||||
Accrued payroll and related liabilities | 54,032 | 78,948 | |||||
Accrued liabilities | 50,950 | 40,697 | |||||
Deferred revenue | 132,447 | 154,821 | |||||
Total current liabilities | 306,157 | 318,953 | |||||
Notes payable | 201,102 | 201,102 | |||||
Deferred revenue, long-term | 17,835 | 18,977 | |||||
Income tax liability | 53,689 | 48,340 | |||||
Other long-term liabilities | 18,035 | 11,574 | |||||
Total liabilities | 596,818 | 598,946 | |||||
Commitments and contingencies (Note 12) | |||||||
Stockholders’ equity: | |||||||
Common stock, no par value, 200,000 shares authorized; 92,360 shares issued and outstanding as of October 31, 2008 and 90,742 shares issued and outstanding as of January 31, 2008 | 565,745 | 531,153 | |||||
Retained earnings (accumulated deficit) | (49,189 | ) | 71,150 | ||||
Accumulated other comprehensive income | 11,092 | 36,864 | |||||
Total stockholders’ equity | 527,648 | 639,167 | |||||
Total liabilities and stockholders’ equity | $ | 1,124,466 | $ | 1,238,113 | |||
See accompanying notes to unaudited condensed consolidated financial statements.
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Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended October 31, | 2008 | 2007 | ||||||
In thousands | ||||||||
Operating Cash Flows: | ||||||||
Net loss | $ | (120,339 | ) | $ | (6,123 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization of property, plant, and equipment | 23,397 | 20,358 | ||||||
Amortization | 19,112 | 15,614 | ||||||
Write-off of debt issuance costs | — | 181 | ||||||
Equity in losses of unconsolidated entities | 1,088 | — | ||||||
Stock-based compensation | 21,133 | 12,486 | ||||||
Deferred income taxes | 5,414 | (30 | ) | |||||
Changes in other long-term liabilities | (1,041 | ) | (2,806 | ) | ||||
In-process research and development | 22,075 | 4,100 | ||||||
Minority interest in net loss of subsidiary | (132 | ) | — | |||||
Loss on disposal of property, plant, and equipment, net | 96 | 184 | ||||||
Changes in operating assets and liabilities, net of effect of acquired businesses: | ||||||||
Trade accounts receivable, net | 80,948 | (15,064 | ) | |||||
Prepaid expenses and other | (13,670 | ) | (8,790 | ) | ||||
Term receivables, long-term | 3,083 | 25,301 | ||||||
Accounts payable and accrued liabilities | (34,143 | ) | (15,740 | ) | ||||
Income taxes receivable and payable | 17,984 | (5,890 | ) | |||||
Deferred revenue | (19,936 | ) | (3,622 | ) | ||||
Net cash provided by operating activities | 5,069 | 20,159 | ||||||
Investing Cash Flows: | ||||||||
Proceeds from sales and maturities of short-term investments | 25,631 | 64,788 | ||||||
Purchases of short-term investments | (19,310 | ) | (35,741 | ) | ||||
Purchases of property, plant, and equipment, net | (33,850 | ) | (29,308 | ) | ||||
Acquisitions of businesses and equity interests, net of cash acquired | (54,485 | ) | (38,045 | ) | ||||
Net cash used in investing activities | (82,014 | ) | (38,306 | ) | ||||
Financing Cash Flows: | ||||||||
Proceeds from issuance of common stock | 14,565 | 17,547 | ||||||
Tax benefit from share options exercised | 25 | — | ||||||
Net decrease in short-term borrowings | (4,464 | ) | (1,745 | ) | ||||
Proceeds from revolving credit facility | 30,000 | — | ||||||
Repayments of notes payable | — | (10,899 | ) | |||||
Net cash provided by financing activities | 40,126 | 4,903 | ||||||
Effect of exchange rate changes on cash and cash equivalents | (3,514 | ) | 1,372 | |||||
Net change in cash and cash equivalents | (40,333 | ) | (11,872 | ) | ||||
Cash and cash equivalents at the beginning of the period | 117,926 | 95,232 | ||||||
Cash and cash equivalents at the end of the period | $ | 77,593 | $ | 83,360 | ||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Notes to Unaudited Condensed Consolidated Financial Statements
(In thousands, except for percentages, per share data, and number of employees)
(1) | General—The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States (U.S.) generally accepted accounting principles and reflect all material normal recurring adjustments. However, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the condensed consolidated financial statements include adjustments necessary for a fair presentation of the results of the interim periods presented. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008. |
The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
(2) | Summary of Significant Accounting Policies |
Principles of Consolidation
The condensed consolidated financial statements include the financial statements of us and our wholly owned and majority-owned subsidiaries. All intercompany accounts and transactions were eliminated in consolidation.
We do not have off-balance sheet arrangements, financings, or other similar relationships with unconsolidated entities or other persons, also known as special purpose entities. In the ordinary course of business, we lease certain real properties, primarily field sales offices, research and development facilities, and equipment, as described in Note 12, “Commitments and Contingencies.”
Revenue Recognition
We report revenue in two categories based upon how the revenue is generated: (i) system and software and (ii) service and support.
System and software revenues – We derive system and software revenues from the sale of licenses of software products, emulation hardware systems, and finance fee revenues from our long-term installment receivables resulting from product sales. We primarily license our products using two different license types:
1. Term licenses – We use this license type primarily for software sales. This license type provides the customer with the right to use a fixed list of software products for a specified time period, typically three years, with payments spread over the license term, and does not provide the customer with the right to use the products after the end of the term. Term license arrangements may allow the customer to share products between multiple locations and remix product usage from the fixed list of products at regular intervals during the license term. We generally recognize product revenue from term license arrangements upon product delivery and start of the license term. In a term license agreement where we provide the customer with rights to unspecified or unreleased future products, we recognize revenue ratably over the license term. Revenue from emulation product sales where the software is incidental to the hardware is generally recognized upon delivery.
2. Perpetual licenses – We use this license type for software and emulation hardware system sales. This license type provides the customer with the right to use the product in perpetuity and typically does not provide for extended payment terms. We generally recognize product revenue from perpetual license arrangements upon product delivery assuming all other criteria for revenue recognition have been met.
We include finance fee revenues from the accretion on the discount of long-term installment receivables in System and software revenues. Finance fee revenues were $3,507 for the three months ended October 31, 2008 and $12,435 for the nine months ended October 31, 2008 compared to $4,178 for the three months ended October 31, 2007 and $12,398 for the nine months ended October 31, 2007.
Service and support revenues – We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which include consulting, training, and other services. We recognize revenue ratably over the support services term. We record professional service revenue as the services are provided to the customer.
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We apply the provisions of Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions,” to all software and hardware product revenue transactions where the software is not incidental. We determine whether product revenue recognition is appropriate based upon the evaluation of whether the following four criteria have been met:
1. Persuasive evidence of an arrangement exists – Generally, we use either a customer signed contract or qualified customer purchase order as evidence of an arrangement for both term and perpetual licenses. For professional service engagements, we generally use a signed professional services agreement and a statement of work to evidence an arrangement. Sales through our distributors are evidenced by an agreement governing the relationship, together with binding purchase orders from the distributor on a transaction-by-transaction basis.
2. Delivery has occurred – We generally deliver software and the corresponding access keys to customers electronically. Electronic delivery occurs when we provide the customer access to the software. We may also deliver the software on a compact disc. Our software license agreements generally do not contain conditions for acceptance. With respect to emulation hardware, we transfer title to the customer upon shipment. We offer non-essential installation services for emulation hardware sales or the customer may elect to perform the installation without assistance from us. Our emulation hardware system agreements generally do not contain conditions for acceptance.
3. Fee is fixed or determinable – We assess whether a fee is fixed or determinable at the outset of the arrangement, primarily based on the payment terms associated with the transaction. We have established a history of collecting under the original contract with installment terms without providing concessions on payments, products, or services. Additionally, for installment contracts, we determine that the fee is fixed or determinable if the arrangement has a payment schedule that is within the term of the licenses and the payments are collected in equal or nearly equal installments, when evaluated on a cumulative basis. If the fee is not deemed to be fixed or determinable, we recognize revenue as payments become due and payable.
4. Collectibility is probable – To recognize revenue, we must judge collectibility of the arrangement fees on a customer-by-customer basis pursuant to our credit review process. We typically sell to customers with whom there is a history of successful collection. We evaluate the financial position and a customer’s ability to pay whenever an existing customer purchases new products, renews an existing arrangement, or requests an increase in credit terms. For certain industries for which our products are not considered core to the industry or the industry is generally considered troubled, we impose higher credit standards. If we determine that collectibility is not probable based upon our credit review process or the customer’s payment history, we recognize revenue as payments are received.
Multiple element arrangements – For multiple element arrangements, vendor-specific objective evidence of fair value (VSOE) must exist to allocate the total fee among all delivered and non-essential undelivered elements of the arrangement. If undelivered elements of the arrangement are essential to the functionality of the product, we defer revenue until the essential elements are delivered. If VSOE does not exist for one or more non-essential undelivered elements, we defer revenue until such evidence does exist for the undelivered elements, or until all elements are delivered, whichever is earlier. If VSOE of all non-essential undelivered elements exists but VSOE does not exist for one or more delivered elements, we recognize revenue using the residual method. Under the residual method, we defer revenue related to the undelivered elements based upon VSOE and we recognize the remaining portion of the arrangement fee as revenue for the delivered elements, assuming all other criteria for revenue recognition have been met. If we could no longer establish VSOE for non-essential undelivered elements of multiple element arrangements, we would defer revenue until all elements are delivered or VSOE is established for the undelivered elements, whichever is earlier.
We base our VSOE for certain product elements of an arrangement upon the pricing in comparable transactions when the element is sold separately. We primarily base our VSOE for term and perpetual support services upon customer renewal history where the services are sold separately. We also base VSOE for professional services and installation services for emulation hardware systems upon the price charged when the services are sold separately.
In accordance with Emerging Issues Task Force (EITF) Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That is, Gross versus Net Presentation),” our policy is to present the Condensed Consolidated Statement of Operations net of taxes collected from customers and remitted to governmental authorities.
Fair Value Measurement
We adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS 157) on February 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring
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fair value, and expands disclosure about fair value measurements. The adoption of SFAS 157 did not impact our consolidated financial position, results of operations, or cash flows. Pursuant to the Financial Accounting Standards Board (FASB) Staff Position (FSP) No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which delayed the adoption of SFAS 157 for nonfinancial assets and liabilities until fiscal years beginning after November 15, 2008, we did not adopt SFAS 157 for nonfinancial assets and liabilities. We are currently evaluating the effect of the adoption of SFAS 157 for nonfinancial assets and liabilities and the impact it will have on our consolidated financial position, results of operations, and cash flows. In October 2008, we adopted the provisions of FSP No. FAS 157-3 “Determining the Market Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP FAS 157-3). FSP FAS 157-3 clarifies the application of SFAS 157 in a market that is not active. The adoption of FSP FAS 157-3 did not impact our consolidated financial position, results of operations, or cash flows.
We also adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159) on February 1, 2008. SFAS 159 requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. We did not elect to apply the fair value option to any financial instruments or other items upon adoption of SFAS 159. As a result, the adoption of SFAS 159 did not impact our consolidated financial position, results of operations, or cash flows.
(3) | Recent Accounting Pronouncements—In July 2008, the EITF issued EITF Issue No. 08-3, “Accounting by Lessees for Nonrefundable Maintenance Deposits” (EITF 08-3) which is effective for fiscal years beginning after December 15, 2008. EITF 08-3 clarifies that lessees should account for nonrefundable maintenance deposits as deposit assets if it is probable that maintenance activities will occur and the deposit is therefore realizable. Amounts on deposit that are not probable of being used to fund future maintenance activities should be charged to expense. We are currently evaluating the effect of the adoption of EITF 08-3 and the impact it will have on our consolidated financial position, results of operations, and cash flows. |
In May 2008, the FASB issued FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (FSP APB 14-1) which is effective for fiscal years beginning after December 15, 2008 and must be applied retrospectively to all periods presented. FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion are not addressed by paragraph 12 of Accounting Principles Board (APB) Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” and thus, that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Based on a preliminary analysis, we have determined that the new guidance will affect our 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026. As a result of the retrospective adoption of FSP APB 14-1, our opening retained earnings will decrease and common stock will increase. However, we are still assessing the magnitude of the changes and the impact on earnings per share.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162) which is effective November 15, 2008. SFAS 162 identifies the sources of generally accepted accounting principles (GAAP) and provides a framework, or hierarchy, for selecting the principles to be used in preparing U.S. GAAP financial statements for nongovernmental entities. We do not anticipate that the adoption of SFAS 162 will have a significant impact on our consolidated financial position, results of operations, or cash flows.
In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (FSP FAS 142-3) which is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. FSP FAS 142-3 amends guidance in SFAS No. 142, “Goodwill and Other Intangible Assets” regarding estimating the useful lives of intangible assets. FSP FAS 142-3 requires additional disclosures related to renewing or extending the terms of recognized intangible assets. In estimating the useful life of a recognized intangible asset, FSP FAS 142-3 requires companies to consider their historical experience in renewing or extending similar arrangements together with the asset’s intended use, regardless of whether the arrangements have explicit renewal or extension provisions. We are currently evaluating the effect of the adoption of FSP FAS 142-3 and the impact it will have on our consolidated financial position, results of operations, and cash flows.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161) which is effective for fiscal years beginning on or after November 15, 2008. SFAS 161 requires companies with derivative instruments to disclose information about how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and how derivative instruments and related hedged items affect a company’s financial position, financial performance, and cash flows. We do not anticipate that the adoption of SFAS 161 will have a significant impact on our consolidated financial position, results of operations, or cash flows.
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In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160) which is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 will require noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. We are currently evaluating the effect of the adoption of SFAS 160 and the impact it will have on our consolidated financial position, results of operations, and cash flows.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (SFAS 141(R)) which is effective for fiscal years beginning on or after December 15, 2008. SFAS 141(R) requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value”. This standard also requires all business combinations to be accounted for by applying the acquisition method and for an acquirer to be identified for each business combination. We are currently evaluating the effect of the adoption of SFAS 141(R) and the impact it will have on our consolidated financial position, results of operations, and cash flows.
In November 2007, the EITF issued EITF Issue No. 07-1 “Accounting for Collaborative Arrangements” (EITF 07-1) which is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. EITF 07-1 defines collaborative arrangements and establishes reporting requirements between participants in collaborative arrangements. We are currently evaluating the effect of the adoption of EITF 07-1 and the impact it will have on our consolidated financial position, results of operations, and cash flows.
(4) | Change in Accounting for Research and Development Credits—The French Finance Act for 2008 (the FFA) was created to increase foreign investment and improve the business environment in France. The FFA included several changes to the research credit program, two of which were changes to the method used to calculate the research credit and the amounts available for credit. The research credit is for certain research costs incurred in France and can be applied against current income tax liabilities due in France for a period of three years. Alternatively, the credit can be refunded by the tax authority three years after being filed in a tax declaration if the company is in a tax loss situation. Due to the changes in its calculation, it is expected that there will be an increase in the amount of credit that will be earned which led us to reevaluate our accounting for this research and development credit. |
Prior to the second quarter of fiscal 2009, we accounted for the research and development credits as an income tax credit which resulted in the treatment of the credit as reduction of income tax expense. For our interim tax calculations this resulted in the credit impacting our overall annual effective tax rate applied to the quarterly periods. However, the research credit can be recovered irrespective of whether we pay income taxes in France and can be predictably determined as research expenditures are incurred. Effective in the second quarter of fiscal 2009, we changed the accounting treatment of the research credit to account for it as a subsidy from the government versus an income tax credit and recorded the credits as a reduction of research and development costs. We have determined that the credits are earned as the qualifying research expenditures are made.
In accordance with SFAS No. 154, “Accounting Changes and Error Corrections,” the change in accounting principle is reported through retrospective application to all prior periods. Due to the methodology used to allocate intra-period income tax expense to each quarter, there are changes to Research and development expense, Total operating expense, Operating income (loss), Loss before income tax and minority interest, Income tax benefit, Net loss, and Net loss per share for each of the prior periods as illustrated in the table below. However, there will be no impact to the previously reported annual amounts of net income, net income per share, or retained earnings.
The impact of the change on Research and development expense, Total operating expenses, Operating income (loss), Loss before income tax and minority interest, Income tax benefit, Net loss, and Net loss per share for the periods presented is as follows:
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Three months ended October 31, 2007 | Nine months ended October 31, 2007 | |||||||
Research and development expense, prior to change | $ | 64,034 | $ | 188,692 | ||||
Impact of accounting change of French research credit | (328 | ) | (1,064 | ) | ||||
Research and development expense, as revised | $ | 63,706 | $ | 187,628 | ||||
Total operating expense, prior to change | $ | 166,794 | $ | 497,634 | ||||
Impact of accounting change of French research credit | (328 | ) | (1,064 | ) | ||||
Total operating expense, as revised | $ | 166,466 | $ | 496,570 | ||||
Operating income (loss), prior to change | $ | (7,603 | ) | $ | 3,514 | |||
Impact of accounting change of French research credit | 328 | 1,064 | ||||||
Operating income (loss), as revised | $ | (7,275 | ) | $ | 4,578 | |||
Loss before income tax and minority interest, prior to change | $ | (11,630 | ) | $ | (7,637 | ) | ||
Impact of accounting change of French research credit | 328 | 1,064 | ||||||
Loss before income tax and minority interest, as revised | $ | (11,302 | ) | $ | (6,573 | ) | ||
Income tax benefit, prior to change | $ | (2,480 | ) | $ | (684 | ) | ||
Impact of accounting change of French research credit | (26 | ) | 234 | |||||
Income tax benefit, as revised | $ | (2,506 | ) | $ | (450 | ) | ||
Net loss, prior to change | $ | (9,150 | ) | $ | (6,953 | ) | ||
Impact of accounting change of French research credit | 354 | 830 | ||||||
Net loss, as revised | $ | (8,796 | ) | $ | (6,123 | ) | ||
Basic net loss per share, prior to change | $ | (0.10 | ) | $ | (0.08 | ) | ||
Impact of accounting change of French research credit | 0.00 | 0.01 | ||||||
Basic net loss per share, as revised | $ | (0.10 | ) | $ | (0.07 | ) | ||
Diluted net loss per share, prior to change | $ | (0.10 | ) | $ | (0.08 | ) | ||
Impact of accounting change of French research credit | 0.00 | 0.01 | ||||||
Diluted net loss per share, as revised | $ | (0.10 | ) | $ | (0.07 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 89,609 | 87,456 | ||||||
Diluted | 89,609 | 87,456 |
We believe the revised presentation is preferable based on our assessment that the research credits are solely based on our research and development spending within France and can be recovered irrespective of whether we pay income tax in France.
(5) | Reclassification of Interest Income and Gain (Loss) On Receivables Sold—Term receivables from customers resulting from the sale of software licenses bear no interest. In accordance with APB Opinion No. 21, “Interest on Receivables and Payables,” we impute interest on term receivables based on prevailing market rates and record this as a discount against the receivables. In our Annual Report on Form 10-K for the fiscal year ended January 31, 2008, we reclassified the interest income resulting from the accretion of the discount of long-term installment receivables from Other income, net, to finance fee revenues included as a component of System and software revenues in the Consolidated Statement of Operations. Prior to the fourth quarter of the year ended January 31, 2008, we reported interest income resulting from the accretion of the discount of long-term installment receivables in interest income, a component of Other income, net, in the Condensed Consolidated Statement of Operations for all periods presented. Along with this change in classification, we have also reclassified the gain or loss on the sale of receivables from Other income, net, to Other general expense (income), net, a component of Operating expenses. The gain or loss on the sale of receivables consists of two components: (i) the discount on sold receivables, which is the difference between the undiscounted balance of the receivables and the net proceeds received from the financing institution, previously |
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referred to as the loss on sale of accounts receivable, and (ii) the unaccreted discount on the receivables sold, which we previously recorded in interest income, a component of Other income, net. These reclassifications have been made to the Condensed Consolidated Statement of Operations for the three and nine months ended October 31, 2007 to conform to the presentation for the current periods. There is no impact on net loss, net loss per share, or beginning retained earnings. |
We believe the revised presentation is preferable based on our assessment that the significance of the sale of term licenses that result in long-term receivables has been increasing and the business has become one of our central operations. The impact of the reclassifications on System and software revenue, Other general expense (income), net, and Other income, net, for the three and nine months ended October 31, 2007 was as follows:
Three Months Ended October 31, 2007 | Nine Months Ended October 31, 2007 | |||||||
System and software revenue, prior to reclassification | $ | 104,215 | $ | 341,764 | ||||
Finance fee revenue | 4,178 | 12,398 | ||||||
System and software revenue, after reclassification | $ | 108,393 | $ | 354,162 | ||||
Other general expense (income), net, prior to reclassification | $ | — | $ | — | ||||
Unaccreted discount on receivables sold | (2,184 | ) | (3,260 | ) | ||||
Discount on sold receivables | 2,362 | 3,222 | ||||||
Other general expense (income), net, after reclassification | $ | 178 | $ | (38 | ) | |||
Other income, net, prior to reclassification | $ | 5,026 | $ | 16,397 | ||||
Interest income on long-term installment receivables | (4,178 | ) | (12,398 | ) | ||||
Unaccreted discount on receivables sold | (2,184 | ) | (3,260 | ) | ||||
Discount on sold receivables | 2,362 | 3,222 | ||||||
Other income, net, after reclassification | $ | 1,026 | $ | 3,961 | ||||
(6) | Fair Value Measurement—Effective February 1, 2008, we adopted SFAS 157 for financial assets and liabilities measured at fair value on a recurring basis, as discussed in Note 2, “Summary of Significant Accounting Policies-Fair Value Measurement.” On a quarterly basis, we measure cash equivalents, short-term investments, and derivatives at fair value. SFAS 157 established a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our market assumptions. SFAS 157 classifies these two types of inputs into the following fair-value hierarchy: |
• | Level 1—Quoted prices for identical instruments in active markets; |
• | Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose significant inputs are observable; and |
• | Level 3—One or more significant inputs to the valuation model are unobservable. |
The following table presents information about financial assets and liabilities required to be carried at fair value on a recurring basis as of October 31, 2008:
Fair Value as of October 31, 2008 | Level 1 | Level 2 | Level 3 | |||||||||||
Cash equivalents | $ | 45,808 | $ | 45,808 | $ | — | $ | — | ||||||
Short-term investments | 1,997 | 1,997 | — | — | ||||||||||
Foreign currency exchange contracts | (8,393 | ) | — | (8,393 | ) | — | ||||||||
Total financial assets and liabilities | $ | 39,412 | $ | 47,805 | $ | (8,393 | ) | $ | — | |||||
We use a market approach to determine the fair value of cash equivalents and short-term investments. Cash equivalents include certificates of deposit, commercial paper, and other highly liquid investments with original
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maturities of ninety days or less. Short-term investments include certificates of deposit, commercial paper, and other highly liquid investments with original maturities in excess of ninety days at the time of purchase and less than one year from the balance sheet date.
We use an income approach to determine the fair value of our foreign currency exchange contracts. For foreign currency exchange contracts designated as cash flow hedges, which are linked to a specific transaction, we report the net gains and losses in Accumulated other comprehensive income in Stockholders’ equity until the forecasted transaction occurs or the hedge is no longer effective. Once the forecasted transaction occurs or the hedge is no longer effective, we reclassify the gains or losses attributable to the foreign currency exchange contract to our Condensed Consolidated Statement of Operations. For foreign currency exchange contracts entered into to offset the variability in exchange rates on certain short-term monetary assets and liabilities, we recognize changes in fair value currently in Other income, net, in our Condensed Consolidated Statement of Operations. See further discussion in Note 9, “Derivative Instruments and Hedging Activities.”
(7) | Business Combinations—In May 2008, our board of directors announced a cash offer to acquire all of the issued or to be issued ordinary shares of Flomerics Group, PLC (Flomerics), a publicly traded company headquartered in Surrey, United Kingdom. Flomerics is a market leader in the computer simulation of mechanical engineering design processes including heat transfer and fluid flow simulation. On July 9, 2008, we obtained greater than 50% of the then outstanding ordinary shares of Flomerics and we began including Flomerics in our results of operations. As of October 31, 2008, we had acquired all of the outstanding or to be outstanding, ordinary shares of Flomerics. We are integrating Flomerics into our Mechanical Analysis products. |
The total purchase price for Flomerics as of October 31, 2008, including acquisition and exit costs, was $58,494. The excess of tangible assets acquired over liabilities assumed was $13,424, including cash of $12,411. We allocated the cost of the acquisition on the basis of the estimated fair value of assets acquired and liabilities assumed. The purchase accounting allocations resulted in goodwill of $19,691, technology of $17,870, other identified intangible assets of $8,000, a charge for in-process research and development of $6,790, and deferred tax liabilities of $7,281. We are amortizing the technology to Cost of revenues and the other identified intangible assets to Operating expenses over three to five years.
On May 12, 2008, we acquired all of the assets and assumed certain liabilities of Ponte Solutions, Inc., a privately held company based in Mountain View, California that develops and markets yield analysis software. The acquisition was an investment aimed at expanding our Design-for-Manufacturing capabilities and was integrated into our Calibre® product family. The total purchase price, including acquisition costs, was $5,686. The excess of liabilities assumed over tangible assets acquired was $431, including cash of $39. We allocated the cost of the acquisition on the basis of the estimated fair value of assets acquired and liabilities assumed. The purchase accounting allocations resulted in goodwill of $2,847, technology of $1,320, other identified intangible assets of $650, and a charge for in-process research and development of $1,300. We are amortizing the technology to Cost of revenues and the other identified intangible assets to Operating expenses over three years.
The separate results of operations for the acquisitions during the nine months ended October 31, 2008 were not material compared to our overall results of operations and accordingly pro forma financial statements of the acquired entities have been omitted. The results of operations of the acquired companies are included in our consolidated financial statements from the date of the respective acquisitions forward.
For many of our acquisitions, payment of a portion of the purchase price is contingent upon the acquired business’ achievement of certain revenue and product performance goals. These contingent payments, or earn-outs, are accrued when the performance goals are met and the contingent consideration is issued or issuable. We recorded earn-outs of $1,738 for the nine months ended October 31, 2008 based on related revenues derived from products and technologies acquired in prior acquisitions. We made earn-out payments of $2,454 for the nine months ended October 31, 2008.
On June 8, 2007, we acquired 100% of the common stock of Sierra Design Automation, Inc. (Sierra), a privately held company based in Santa Clara, California, which is a provider of high-performance place and route software solutions. The acquisition was an investment aimed at expanding our Design-for-Manufacturing capabilities and increasing revenue growth. Upon completion of the merger transaction, the outstanding shares of Sierra were converted into the right to receive consideration from us totaling $90,000, of which $45,000 was payable in cash and $45,000 was payable in the form of 3,097 shares of our common stock valued as provided in the merger agreement at $14.53 per share which was the average closing price reported by NASDAQ for the 10 trading-day period ending three days before the closing. Cash of $3,717 and 256 shares of our common stock with a value of $3,721 were withheld pro rata from the former Sierra shareholders and deposited in an indemnity escrow account; these amounts were released in October 2008. The indemnity escrow account also includes $783 of cash and 56 shares of our common stock valued at $810 withheld from Sierra’s two founders; these amounts plus an additional 166 shares of our common stock valued at
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$2,407 withheld from the founders are subject to forfeiture if their employment with us is terminated by them without good reason or by us for cause before June 8, 2009.
In accounting for the Sierra transaction, we are required to value the shares of our common stock issued in the transaction at $13.85 per share which was the average closing price reported by NASDAQ for the five day period beginning with the two day period preceding the measurement date through the two days succeeding the measurement date. In addition, the cash and common stock withheld from the two Sierra founders of $3,797, which is subject to a continued employment requirement, is considered compensation expense to be recognized over the service period and is not included in the acquisition cost. The common stock withheld from the two Sierra founders was valued at $13.61 per share. After this adjustment, the total purchase price of Sierra, including transaction costs, was $84,818. The excess of tangible assets acquired over liabilities assumed was $6,385, including $9,716 of acquired cash. We allocated the cost of the acquisition on the basis of the estimated fair value of assets acquired and liabilities assumed. The purchase accounting allocations resulted in a charge for in-process research and development of $4,100, goodwill of $45,932, technology of $9,400, other identified intangible assets of $17,200, and deferred tax assets of $1,801. We are amortizing the technology to Cost of revenues and the other identified intangible assets to Operating expenses over three years. The results of Sierra’s operations are included in our consolidated financial statements from the date of acquisition forward.
We recorded earn-outs of $1,773 for the nine months ended October 31, 2007 based on related revenues derived from products and technologies acquired in prior acquisitions. We made earn-out payments of $2,136 for the nine months ended October 31, 2007.
(8) | Long-Term Investments—In January 2008, we agreed to purchase $2,000 of Series D Preferred Stock of Calypto Design Systems, Inc. (Calypto). Calypto is an electronic design automation company with two main products: (i) SLEC, an equivalence checking tool and (ii) PowerPro, a power reduction tool. The Series D Preferred Stock is convertible into common shares at our option at any time. We purchased $1,000 of the Series D Preferred Stock in January 2008. During the second quarter of fiscal 2009, we purchased the remaining $1,000 of the Series D Preferred Stock as a result of Calypto substantially meeting certain booking and development milestones established at the time of our initial purchase. |
As of October 31, 2008, we controlled 30.3% of the voting stock of Calypto and 20% of the participating membership of the board of directors. We have determined our investment in Calypto to be “in-substance common stock” as described in EITF 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock.” Accordingly, we have accounted for our investment in Calypto pursuant to the equity method of accounting in accordance with APB Opinion No. 18, “The Equity Method of Accounting for Certain Investments in Debt and Equity Securities.” We record our interest in the equity method gains or losses of Calypto in the subsequent quarter following incurrence because it is not practical to obtain Calypto’s financial statements prior to the issuance of our consolidated financial statements. During the three months ended October 31, 2008, we recorded a loss of $445 in Other income, net, in our Condensed Consolidated Statement of Operations for our equity in the losses of Calypto for the three months ended July 31, 2008. For the nine months ended October 31, 2008, we recorded a loss of $1,088 for our equity in the losses of Calypto from our initial investment in January 2008 through July 31, 2008.
(9) | Derivative Instruments and Hedging Activities—We are exposed to fluctuations in foreign currency exchange rates. To manage the volatility, we aggregate exposures on a consolidated basis to take advantage of natural offsets. The primary exposures that do not currently have natural offsets are the Japanese yen, where we are in a long position, and the euro and the British pound, where we are in a short position. Most large European revenue contracts are denominated and paid to us in the U.S. dollar while our European expenses, including substantial research and development operations, are paid in local currencies causing a short position in the euro and the British pound. In addition, we experience greater inflows than outflows of Japanese yen as almost all Japanese-based customers contract and pay us in Japanese yen. While these exposures are aggregated on a consolidated basis to take advantage of natural offsets, substantial exposure remains. |
We generated nearly two-thirds of our revenues and approximately one-third of our expenses outside of the U.S. for the nine months ended October 31, 2008. For the nine months ended October 31, 2008, approximately one-fourth of European and ninety percent of Japanese revenues were subject to exchange rate fluctuation as they were booked in local currencies. For the nine months ended October 31, 2007, approximately one-fourth of European and substantially all of Japanese revenues were subject to exchange rate fluctuation.
For exposures that are not offset, we enter into short-term foreign currency forward and option contracts to partially offset these anticipated exposures. We formally document all relationships between foreign currency forward and option contracts and hedged items as well as our risk management objectives and strategies for undertaking various hedge transactions. All hedges designated as cash flow hedges are linked to forecasted transactions and we assess, both at inception of the hedge and on an ongoing basis, the effectiveness of the foreign currency forward and option
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contracts in offsetting changes in the cash flows of the hedged items. We report the effective portions of the net gains or losses on foreign currency forward and option contracts as a component of Accumulated other comprehensive income in Stockholders’ equity. Accumulated other comprehensive income associated with hedges of forecasted transactions is reclassified to the Condensed Consolidated Statement of Operations in the same period the forecasted transaction occurs. We discontinue hedge accounting prospectively when we determine that a foreign currency forward or option contract is not highly effective as a hedge under the requirements of SFAS 133. To the extent a forecasted transaction is no longer deemed probable of occurring, we prospectively discontinue hedge accounting treatment and we reclassify deferred amounts to Other income, net.
We had $337,562 of notional value foreign currency forward and option contracts outstanding as of October 31, 2008 and $387,606 outstanding as of January 31, 2008. Notional amounts do not quantify risk or represent our assets or liabilities but are used in the calculation of cash settlements under the contracts. As of October 31, 2008, the fair value of foreign currency forward and option contracts had a net liability balance of $8,393, recorded in Accrued liabilities in the Condensed Consolidated Balance Sheet. As of January 31, 2008, the fair value of foreign currency forward and option contracts had a net asset balance of $687, and was recorded in Other receivables.
The following provides a summary of activity in Accumulated other comprehensive income for our net unrealized gain (loss) relating to our hedging program:
2008 | 2007 | |||||||
Balance as of January 31 | $ | 26 | $ | 1,596 | ||||
Change in fair value of cash flow hedges | (7,345 | ) | 1,714 | |||||
Hedge ineffectiveness recognized in earnings | 75 | (2 | ) | |||||
Net gain transferred to earnings | (482 | ) | (1,817 | ) | ||||
Balance as of October 31 | $ | (7,726 | ) | $ | 1,491 | |||
The hedge-related balance in Accumulated other comprehensive income as of October 31, 2008 represents a net unrealized loss on foreign currency forward and option contracts relating to hedges of forecasted revenues and expenses expected to occur during fiscal 2009 and fiscal 2010. We will transfer these amounts to the Condensed Consolidated Statement of Operations upon recognition of the related revenue and recording of the respective expenses. We expect substantially all of the balance in Accumulated other comprehensive income to be reclassified to the Condensed Consolidated Statement of Operations within the next twelve months. We transferred a deferred loss of $2,375 to System and software revenues relating to foreign currency forward and option contracts hedging revenues for the nine months ended October 31, 2008 compared to a deferred gain of $301 for the nine months ended October 31, 2007. We transferred a deferred gain of $2,857 to Operating expenses relating to foreign currency forward and option contracts hedging commission and other expenses for the nine months ended October 31, 2008 compared to $1,516 for the nine months ended October 31, 2007.
We enter into foreign currency contracts to offset the earnings impact relating to the variability in exchange rates on certain short-term monetary assets and liabilities denominated in non-functional currencies. We do not designate these foreign currency contracts as hedges. We recognize changes in the fair value of these foreign currency contracts currently in earnings in Other income, net, to offset the remeasurement of the related assets and liabilities.
In accordance with SFAS 133, we exclude changes in fair value relating to time value of foreign currency forward contracts from our assessment of hedge effectiveness. We recorded income relating to time value in interest income, a component of Other income, net, of $684 for the three months ended October 31, 2008 and $2,028 for the nine months ended October 31, 2008 compared to $508 for the three months ended October 31, 2007 and $1,602 for the nine months ended October 31, 2007. We recorded expense related to time value in Interest expense of $701 for the three months ended October 31, 2008 and $1,764 for the nine months ended October 31, 2008 compared to $440 for the three months ended October 31, 2007 and $1,393 for the nine months ended October 31, 2007.
(10) | Short-Term Borrowings—In June 2005, we entered into a syndicated, senior, unsecured, four-year revolving credit facility that replaced an existing three-year revolving credit facility. In April 2008, we extended this revolving credit facility by two years until June 1, 2011. In May 2008, we increased the maximum borrowing capacity from $120,000 to $140,000 and retained an option to increase it by an additional $10,000 in the future. Under this revolving credit facility, we have the option to pay interest based on: (i) LIBOR with varying maturities which are commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) prime plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. As a result, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.25% and 0.35% based on a pricing grid |
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tied to a financial covenant. We paid commitment fees of $89 for the three months ended October 31, 2008 and $259 for the nine months ended October 31, 2008 compared to $77 for the three months ended October 31, 2007 and $228 for the nine months ended October 31, 2007. This revolving credit facility contains certain financial and other covenants, including financial covenants requiring the maintenance of specified liquidity ratios, leverage ratios, and minimum tangible net worth as well as restrictions on the payment of cash dividends. We borrowed $30,000 against the revolving credit facility during the three and nine months ended October 31, 2008. We had no borrowings during the three and nine months ended October 31, 2007. As of October 31, 2008, we had an outstanding balance of $30,000. The interest rate on October 31, 2008 was 4.00%. As of January 31, 2008, we had no outstanding balance against this revolving credit facility. |
Short-term borrowings of $5,601 as of October 31, 2008 and $10,449 as of January 31, 2008 represent amounts collected from customers on accounts receivable previously sold on a non-recourse basis to financial institutions. These amounts are remitted to the financial institutions during the quarter following the period end.
We generally have other short-term borrowings, including multi-currency lines of credit, capital leases, and other borrowings. Interest rates are generally based on the applicable country’s prime lending rate, depending on the currency borrowed. Other short-term borrowings outstanding under these facilities were $4,104 as of October 31, 2008 and $3,729 as of January 31, 2008.
(11) | Notes Payable—Notes payable consisted of the following: |
As of | ||||||
October 31, 2008 | January 31, 2008 | |||||
6.25% Debentures due 2026 | $ | 165,000 | $ | 165,000 | ||
Floating Rate Debentures due 2023 | 36,102 | 36,102 | ||||
Notes Payable | $ | 201,102 | $ | 201,102 | ||
6.25% Debentures due 2026: In March 2006, we issued $200,000 of 6.25% Debentures in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the 6.25% Debentures is payable semi-annually in March and September. The 6.25% Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $17.968 per share for a total of 9,183 shares as of October 31, 2008. These circumstances generally include:
• | The market price of our common stock exceeding 120% of the conversion price; |
• | The market price of the 6.25% Debentures declining to less than 98% of the value of the common stock into which the 6.25% Debentures are convertible; |
• | A call for the redemption of the 6.25% Debentures; |
• | Specified distributions to holders of our common stock; |
• | If a fundamental change, such as a change of control, occurs; or |
• | During the ten trading days prior to, but not on, the maturity date. |
Upon conversion, in lieu of shares of our common stock, for each $1 principal amount of the 6.25% Debentures a holder will receive an amount of cash equal to the lesser of: (i) $1 or (ii) the conversion value of the number of shares of our common stock equal to the conversion rate. If such conversion value exceeds $1, we will also deliver, at our election, cash or common stock, or a combination of cash and common stock with a value equal to the excess. If a holder elects to convert their 6.25% Debentures in connection with a fundamental change in the company that occurs prior to March 6, 2011, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances. The 6.25% Debentures rank pari passu with the Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023. We may redeem some or all of the 6.25% Debentures for cash on or after March 6, 2011. The holders, at their option, may redeem some or all of the 6.25% Debentures for cash on March 1, 2013, 2016, or 2021. During the nine months ended October 31, 2008, we did not repurchase any 6.25% Debentures and the principal amount of $165,000 remains outstanding.
Floating Rate Debentures due 2023: In August 2003, we issued $110,000 of Floating Rate Debentures in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the Floating Rate Debentures is payable quarterly in February, May, August, and November at a variable interest rate equal to 3-month LIBOR plus 1.65%. The effective interest rate was 4.60% for the nine months ended October 31, 2008 and 7.01% for the nine
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months ended October 31, 2007. The Floating Rate Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $23.40 per share, for a total of 1,543 shares as of October 31, 2008. These circumstances generally include:
• | The market price of our common stock exceeding 120% of the conversion price; |
• | The market price of the Floating Rate Debentures declining to less than 98% of the value of the common stock into which the Floating Rate Debentures are convertible; or |
• | A call for redemption of the Floating Rate Debentures or certain other corporate transactions. |
The conversion price may also be adjusted based on certain future transactions, such as stock splits or stock dividends. Effective August 2008, we may redeem some or all of the Floating Rate Debentures for cash at 101.61% of the face amount, with the premium reducing to 0.81% on August 6, 2009 and 0% on August 6, 2010. The holders, at their option, may redeem some or all of the Floating Rate Debentures for cash on August 6, 2010, 2013, or 2018. During the nine months ended October 31, 2008, we did not repurchase any Floating Rate Debentures and the principal amount of $36,102 remains outstanding.
(12) | Commitments and Contingencies |
Leases
We lease a majority of our field sales offices and research and development facilities under non-cancelable operating leases. In addition, we lease certain equipment used in our research and development activities. This equipment is generally leased on a month-to-month basis after meeting a six-month lease minimum. There have been no significant changes to the future minimum lease payments due under non-cancelable operating leases as disclosed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008.
Income Taxes
As of October 31, 2008, we had a liability of approximately $53,689 for income taxes associated with uncertain income tax positions. All of these liabilities are classified as long-term liabilities in our Condensed Consolidated Balance Sheet, as we generally do not anticipate the settlement of the liabilities will require payment of cash within the next twelve months. Further, certain liabilities may result in the reduction of deferred tax assets rather than settlement in cash. We are not able to reasonably estimate the timing of any cash payments required to settle these liabilities and do not believe that the ultimate settlement of these obligations will materially affect our liquidity.
Contractual Obligations
In conjunction with the acquisition of undeveloped 22 nanometer (nm) technology we acquired under a joint development agreement entered into during the second quarter of fiscal 2009, we are required to make payments of $2,500 during fiscal 2009, $5,000 during fiscal 2010, and annual payments of $2,500 during each of fiscal 2011 through fiscal 2013. Of the $2,500 due in fiscal 2009, we paid $1,250 during the three months ended October 31, 2008. See further discussion of the joint development agreement in Note 18, “In-Process Research and Development.”
Indemnifications
Our license and service agreements generally include a limited indemnification provision for claims from third parties relating to our intellectual property. These indemnification provisions are accounted for in accordance with SFAS No. 5, “Accounting for Contingencies” (SFAS 5). The indemnification is generally limited to the amount paid by the customer or a set cap. As of October 31, 2008, we were not aware of any material liabilities arising from these indemnifications.
Legal Proceedings
From time to time we are involved in various disputes and litigation matters that arise from the ordinary course of business. These include disputes and lawsuits relating to intellectual property rights, contracts, distributorships, and employee relations matters. Periodically, we review the status of various disputes and litigation matters and assess each potential exposure. When we consider the potential loss from any dispute or legal matter probable and the amount or the range of loss can be estimated, we will accrue a liability for the estimated loss in accordance with SFAS 5. Legal proceedings are subject to uncertainties and the outcomes are difficult to predict. Because of such uncertainties, we base accruals only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation matters and may revise estimates. We believe that the outcome of current litigation, individually and in the aggregate, will not have a material effect on our results of operations.
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(13) | Accounting for Stock-Based Compensation |
Stock Option Plans and Stock Plans
We have two common stock option plans which provide for the granting of incentive stock options, nonqualified stock options (NQSOs), stock appreciation rights, restricted stock, restricted stock units, and performance-based awards. The two common stock option plans are administered by the Compensation Committee of our Board of Directors and permit accelerated vesting of outstanding options upon the occurrence of certain changes in control of our company.
We also have a stock plan that provides for the sale of common stock to our officers, key employees, and non-employee consultants. This plan allows for shares to be awarded at no purchase price as a stock bonus or with a purchase price as a NQSO.
Stock options under the above three plans generally expire ten years from the date of grant and become exercisable over four years from the date of grant or from the commencement of employment, at prices generally not less than the fair market value at the date of grant.
We have a Director’s Stock Plan that provides for the annual grant to each non-employee director of either an option for 21 shares of common stock or 7 shares of restricted stock, each vesting over a period of five years but with accelerated vesting upon any termination of service. During the nine months ended October 31, 2008, there were 14 shares of restricted stock with a fair market value of $214 issued under this plan. During the nine months ended October 31, 2007, there were 28 shares of restricted stock with a fair market value of $381 issued under this plan. Options granted under this plan are included in the table below.
As of October 31, 2008, a total of 7,865 shares of common stock were available for future grant under the above stock option and stock plans.
Stock options outstanding, the weighted average exercise price, and transactions involving the stock option plans are summarized as follows:
Shares | Price | |||||
Balance as of January 31, 2008 | 19,693 | $ | 14.18 | |||
Granted | 461 | $ | 12.06 | |||
Exercised | (653 | ) | $ | 8.74 | ||
Forfeited | (237 | ) | $ | 13.85 | ||
Expired | (1,150 | ) | $ | 13.18 | ||
Balance as of October 31, 2008 | 18,114 | $ | 14.39 | |||
Employee Stock Purchase Plans
We have an employee stock purchase plan (ESPP) for U.S. employees and an ESPP for certain foreign subsidiary employees. The ESPPs generally provide for overlapping two-year offerings starting every six months on January 1 and July 1 of each year with purchases every six months during those offerings. Each eligible employee may purchase up to sixteen hundred shares of stock on each purchase date at prices no less than 85% of the lesser of the fair market value of the shares at the beginning of the two-year offering period or on the applicable purchase date. As of October 31, 2008, 7,303 shares remain available for future purchase under the ESPPs.
Stock-Based Compensation Expense
We estimate the fair value of stock options and purchase rights under our ESPPs in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment,” using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model incorporates several highly subjective assumptions including expected volatility, expected term, and interest rates. We include the following elements in reaching our determination of expected volatility:
• | Historical volatility of our shares of common stock; |
• | Historical volatility of shares of comparable companies; |
• | Implied volatility of the option features in our convertible subordinated debentures; and |
• | Implied volatility of traded options of comparable companies. |
We base the expected term of our stock options on historical experience. Using the Black-Scholes option-pricing model, the weighted average fair values are summarized as follows:
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Three Months Ended October 31, | Nine Months Ended October 31, | |||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||
Options granted | $ | 4.01 | $ | 7.62 | $ | 5.50 | $ | 7.60 | ||||
Restricted stock granted | $ | — | $ | — | $ | 15.29 | $ | 13.61 | ||||
ESPP purchase rights | $ | 4.95 | $ | 4.01 | $ | 4.68 | $ | 4.21 |
The calculations used the following assumptions:
Three Months Ended October 31, | Nine Months Ended October 31, | |||||||||||
Stock Option Plans | 2008 | 2007 | 2008 | 2007 | ||||||||
Risk-free interest rate | 2.9 | % | 4.3 - 4.4 | % | 2.7 - 3.6 | % | 4.3 - 4.9 | % | ||||
Dividend yield | 0 | % | 0 | % | 0 | % | 0 | % | ||||
Expected life (in years) | 5.0 | 5.0 - 6.3 | 5.0 - 6.5 | 4.5 - 6.3 | ||||||||
Volatility (range) | 45 | % | 45 - 50 | % | 45 - 50 | % | 45 - 55 | % | ||||
Volatility (weighted average) | 45 | % | 47 | % | 46 | % | 48 | % | ||||
Three Months Ended October 31, | Nine Months Ended October 31, | |||||||||||
Employee Stock Purchase Plans | 2008 | 2007 | 2008 | 2007 | ||||||||
Risk-free interest rate | 4.6% | 5.0% | 4.7% | 5.0% | ||||||||
Dividend yield | 0% | 0% | 0% | 0% | ||||||||
Expected life (in years) | 1.25 | 1.25 | 1.25 | 1.25 | ||||||||
Volatility (range) | 34 - 45% | 45% | 33 - 45% | 45% | ||||||||
Volatility (weighted average) | 43% | 45% | 43% | 45% |
In August 2008, we modified 5,855 stock options to extend the exercise period from 30 days to 12 months upon the occurrence of a change in control and other certain triggering events. The modification was valued at $880. For the three months ended October 31, 2008, we recognized expense of $657. The balance of the expense will be amortized over four years.
We issued 222 shares of common stock valued at $3,014 to the founders of a company we acquired in June 2007. These shares are subject to forfeiture if their employment terminates prior to June 2009. The value of these shares is being amortized over the two year period.
(14) | Net Loss Per Share—We compute basic net loss per share using the weighted average number of common shares outstanding during the period. We compute diluted net loss per share using the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of common shares issuable upon exercise of employee stock options, purchase rights from ESPPs, and warrants using the treasury stock method. Potentially dilutive common shares also include common shares issuable upon conversion of the convertible subordinated debentures, if dilutive. |
The following provides the computation of basic and diluted net loss per share:
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Net loss | $ | (78,244 | ) | $ | (8,796 | ) | $ | (120,339 | ) | $ | (6,123 | ) | ||||
Weighted average common shares used to calculate diluted net loss per share | 92,354 | 89,609 | 91,484 | 87,456 | ||||||||||||
Basic net loss per share | $ | (0.85 | ) | $ | (0.10 | ) | $ | (1.32 | ) | $ | (0.07 | ) | ||||
Diluted net loss per share | $ | (0.85 | ) | $ | (0.10 | ) | $ | (1.32 | ) | $ | (0.07 | ) | ||||
We excluded from the computation of diluted net loss per share options and warrants to purchase 18,213 shares of common stock for the three and nine months ended October 31, 2008 compared to 18,709 for the three months ended October 31, 2007 and 18,488 for the nine months ended October 31, 2007. The options and warrants were anti-dilutive either because we incurred a net loss for the period, the warrant price was greater than the average market price of the common stock during the period, or the option was determined to be anti-dilutive as a result of applying the treasury stock method in accordance with SFAS No. 128, “Earnings per Share” (SFAS 128).
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We excluded from the computation of diluted net loss per share the effect of the conversion of the Floating Rate Debentures and the 6.25% Debentures as they were anti-dilutive. If the Floating Rate Debentures had been dilutive, our diluted net loss would have included additional earnings of $280 for the three months ended October 31, 2008 and $866 for the nine months ended October 31, 2008 compared to $655 for the three months ended October 31, 2007 and $1,795 for the nine months ended October 31, 2007. Also included would have been incremental common shares of 1,543 for the three and nine months ended October 31, 2008 compared to 1,710 for the three months ended October 31, 2007 and 1,913 for the nine months ended October 31, 2007. In accordance with SFAS 128, we assume that the 6.25% Debentures will be settled in common stock for purposes of calculating the dilutive effect of the 6.25% Debentures. If the effect of the 6.25% Debentures had been dilutive, our diluted net loss would have included additional earnings of $1,057 for the three and nine months ended October 31, 2008 compared to $1,281 for the three and nine months ended October 31, 2007. Dilutive net loss would have included no incremental shares for the three and nine months ended October 31, 2008 and 2007, as the stock price was below the conversion rate. The conversion features of the 6.25% Debentures, which allow for settlement in cash, common stock, or a combination of cash and common stock, are further described in Note 11, “Notes Payable.”
(15) | Comprehensive Income (Loss)—The following provides a summary of comprehensive income (loss): |
Nine Months Ended October 31, | 2008 | 2007 | ||||||
Net loss | $ | (120,339 | ) | $ | (6,123 | ) | ||
Change in unrealized loss on derivative instruments | (7,752 | ) | (105 | ) | ||||
Change in accumulated translation adjustment | (18,020 | ) | 10,908 | |||||
Comprehensive income (loss) | $ | (146,111 | ) | $ | 4,680 | |||
(16) | Special Charges—The following is a summary of the major elements of the special charges: |
Three months ended October 31, | Nine months ended October 31, | |||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||
Employee severance and related costs | $ | 350 | $ | 1,115 | $ | 9,194 | $ | 5,798 | ||||||
Excess leased facility costs | (409 | ) | — | 2,547 | (737 | ) | ||||||||
Other costs | 2,273 | — | 3,358 | 99 | ||||||||||
Total special charges | $ | 2,214 | $ | 1,115 | $ | 15,099 | $ | 5,160 | ||||||
During the nine months ended October 31, 2008, we recorded special charges of $15,099. These charges primarily consisted of costs incurred for employee terminations and were due to our reduction of personnel resources driven by modifications of business strategy or business emphasis.
We rebalanced our workforce by 136 employees during the nine months ended October 31, 2008. The reduction impacted several employee groups. Employee severance costs of $9,194 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans, none of which was individually material to our financial position or results of operations. We determined the termination benefit amount based on employee status, years of service, and local statutory requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Approximately 77% of these costs were paid during the nine months ended October 31, 2008. We expect to pay the remainder during the fiscal year ending January 31, 2009. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $2,547 during the nine months ended October 31, 2008 were primarily due to the abandonment of six leased facilities and changes in the estimate of sublease income for previously abandoned leased facilities.
Other special charges for the nine months ended October 31, 2008 included costs of $3,345 related to advisory fees incurred in response to the unsolicited offer by Cadence Design Systems, Inc. to acquire us, costs of $93 related to the closure of a division, and other charges of $(80).
During the nine months ended October 31, 2007, we recorded special charges of $5,160. These charges primarily consisted of costs incurred for employee terminations and were due to our reduction of personnel resources driven by modifications of business strategy or business emphasis.
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We rebalanced our workforce by 138 employees during the nine months ended October 31, 2007. The reduction impacted several employee groups. Employee severance costs of $5,798 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans, none of which was individually material to our financial position or results of operations. We determined the termination benefit amount based on employee status, years of service, and local statutory requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Substantially all of these costs were paid during the fiscal year ended January 31, 2008. There have been no significant modifications to the amount of these charges.
The reduction of excess leased facility costs of $737 during the nine months ended October 31, 2007 resulted from the re-occupancy of a previously abandoned leased facility in the second quarter of fiscal 2008 and the termination of an abandoned facility lease in a lease buyout in the first quarter of fiscal 2008. The cost of the lease buyout was less than the remaining balance of the accrual, resulting in an adjustment to special charges.
Accrued special charges are included in Accrued liabilities and Other long-term liabilities in the Condensed Consolidated Balance Sheets. The following table shows changes in accrued special charges during the nine months ended October 31, 2008:
Accrued special charges as of January 31, 2008 | Charges during the nine months ended October 31, 2008 | Payments during the nine months ended October 31, 2008 | Accrued special charges as of October 31, 2008 (1) | ||||||||||
Employee severence and related costs | $ | 3,903 | $ | 9,194 | $ | (10,117 | ) | $ | 2,980 | ||||
Excess leased facility costs | 3,507 | 2,547 | (830 | ) | 5,224 | ||||||||
Other costs | — | 3,358 | (1,622 | ) | 1,736 | ||||||||
Total accrued special charges | $ | 7,410 | $ | 15,099 | $ | (12,569 | ) | $ | 9,940 | ||||
(1) | Of the $9,940 total accrued special charges as of October 31, 2008, $3,269 represented the long-term portion of accrued lease termination fees and other facility costs, net of sublease income. The remaining balance of $6,671 represented the short-term portion of accrued special charges. |
(17) | Other Income, Net—Other income, net was comprised of the following: |
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Interest income | $ | 1,099 | $ | 1,631 | $ | 4,013 | $ | 5,456 | ||||||||
Gain (loss) on hedge ineffectiveness | (89 | ) | 8 | (75 | ) | 2 | ||||||||||
Foreign currency exchange gain (loss) | 1,286 | (347 | ) | 2,397 | (891 | ) | ||||||||||
Equity in losses of unconsolidated entities | (445 | ) | — | (1,088 | ) | — | ||||||||||
Other, net | (157 | ) | (266 | ) | (550 | ) | (606 | ) | ||||||||
Other income, net | $ | 1,694 | $ | 1,026 | $ | 4,697 | $ | 3,961 | ||||||||
(18) | In-Process Research and Development—We incurred $13,985 of in-process research and development charges during the second quarter of 2009 related to undeveloped technology acquired through a joint development agreement addressing technological challenges of integrated circuit design at 22 nm geometries. We based the value of the charge on the present value of the four year payment obligation as defined in the agreement. The joint development agreement provides access to technology which has not yet reached technological feasibility and provides no alternative future use. The technology is expected to be the basis for a new offering in the Calibre® product family once development is completed. |
Other in-process research and development charges for the three and nine months ended October 31, 2008 and 2007 relate to acquisitions of businesses. See further discussion of these amounts in Note 7, “Business Combinations.”
(19) | Related Party Transactions—Certain members of our board of directors also serve on the board of directors of certain of our customers. We recognized revenue from these customers of $9,835 for the three months ended October 31, 2008 and $36,466 for the nine months ended October 31, 2008. These amounts represented 5.3% of our total revenues for the three months ended October 31, 2008 and 6.7% for the nine months ended October 31, 2008. We recognized revenue from these customers of $7,842 for the three months ended October 31, 2007 and $23,949 for the nine months |
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ended October 31, 2007, representing 4.1% of our total revenues for the three months ended October 31, 2007 and 4.0% for the nine months ended October 31, 2007. Management believes the transactions between these customers and us were carried out on an arm’s-length basis.
(20) | Supplemental Cash Flow Information—The following provides information concerning supplemental disclosures of cash flow activities: |
Nine months ended October 31, | 2008 | 2007 | ||||
Cash paid, net for: | ||||||
Interest (1) | $ | 14,030 | $ | 17,214 | ||
Income taxes | $ | 4,840 | $ | 8,700 |
(1) | Cash paid for interest for the nine months ended October 31, 2007 included $271 for the premium on the Floating Rate Debentures. |
During the nine months ended October 31, 2007, we acquired Sierra using a combination of cash and stock. Common stock with a fair value of $39,831 was issued in connection with the acquisition of Sierra which included both an initial payment and a holdback payment.
(21) | Segment Reporting—SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS 131) requires disclosures of certain information regarding operating segments, products and services, geographic areas of operation, and major customers. To determine what information to report under SFAS 131, we reviewed our Chief Operating Decision Makers’ (CODM) method of analyzing the operating segments to determine resource allocations and performance assessments. Our CODMs are the Chief Executive Officer, President, and Chief Financial Officer. |
We operate exclusively in the electronic design automation industry. We market our products and services worldwide, primarily to large companies in the military/aerospace, communications, computer, consumer electronics, semiconductor, networking, multimedia, and transportation industries. We sell and license our products through our direct sales force in North America, Europe, Japan, and the Pacific Rim and through distributors where third parties can extend our sales reach more effectively or efficiently. Our CODMs review our consolidated results within one operating segment. In making operating decisions, our CODMs primarily consider consolidated financial information accompanied by disaggregated information by geographic region.
We eliminate all intercompany revenues and expenses in computing Revenues, Operating income (loss), and Income (loss) before income tax and minority interest. The corporate component of Operating income (loss) represents research and development, corporate marketing and selling, corporate general and administration, other general expense (income), special charges, and in-process research and development charges. Geographic information is as follows:
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Three months ended October 31, | Nine months ended October 31, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Revenues: | ||||||||||||||||
North America | $ | 76,210 | $ | 78,783 | $ | 212,325 | $ | 284,779 | ||||||||
Europe | 62,283 | 48,338 | 173,847 | 137,651 | ||||||||||||
Japan | 20,709 | 36,308 | 89,143 | 86,419 | ||||||||||||
Pacific Rim | 25,650 | 27,060 | 71,148 | 86,063 | ||||||||||||
Total revenues | $ | 184,852 | $ | 190,489 | $ | 546,463 | $ | 594,912 | ||||||||
Operating income (loss): | ||||||||||||||||
North America | $ | 40,812 | $ | 41,722 | $ | 107,900 | $ | 171,297 | ||||||||
Europe | 35,909 | 23,208 | 90,008 | 62,657 | ||||||||||||
Japan | 10,852 | 25,805 | 59,086 | 58,769 | ||||||||||||
Pacific Rim | 18,599 | 19,506 | 50,616 | 65,665 | ||||||||||||
Corporate | (131,514 | ) | (117,516 | ) | (393,524 | ) | (353,810 | ) | ||||||||
Total operating income (loss) | $ | (25,342 | ) | $ | (7,275 | ) | $ | (85,914 | ) | $ | 4,578 | |||||
Loss before income tax and minority interest: | ||||||||||||||||
North America | $ | 37,254 | $ | 37,909 | $ | 98,325 | $ | 160,058 | ||||||||
Europe | 36,923 | 23,000 | 91,918 | 62,805 | ||||||||||||
Japan | 10,837 | 25,773 | 59,057 | 58,688 | ||||||||||||
Pacific Rim | 18,582 | 19,532 | 50,777 | 65,686 | ||||||||||||
Corporate | (131,514 | ) | (117,516 | ) | (393,524 | ) | (353,810 | ) | ||||||||
Total loss before income tax and minority interest | $ | (27,918 | ) | $ | (11,302 | ) | $ | (93,447 | ) | $ | (6,573 | ) | ||||
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As of | October 31, 2008 | January 31, 2008 | ||||
Total assets: | ||||||
North America | $ | 741,633 | $ | 807,742 | ||
Europe | 266,827 | 302,999 | ||||
Japan | 81,286 | 80,540 | ||||
Pacific Rim | 34,720 | 46,832 | ||||
Total | $ | 1,124,466 | $ | 1,238,113 | ||
We segregate revenue into six categories of similar products and services. Each category, with the exception of Finance Fees, includes both product and related support revenues. Revenue information is as follows:
Three months ended October 31, | Nine months ended October 31, | |||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||
Revenues: | ||||||||||||
Integrated System Design | $ | 48,999 | $ | 46,768 | $ | 124,234 | $ | 132,025 | ||||
IC Design to Silicon | 54,281 | 51,945 | 173,769 | 200,826 | ||||||||
Scalable Verification | 42,483 | 47,989 | 128,354 | 134,945 | ||||||||
New & Emerging Products | 22,497 | 27,345 | 72,328 | 79,289 | ||||||||
Services & Other | 13,085 | 12,264 | 35,343 | 35,429 | ||||||||
Finance Fees | 3,507 | 4,178 | 12,435 | 12,398 | ||||||||
Total revenues | $ | 184,852 | $ | 190,489 | $ | 546,463 | $ | 594,912 | ||||
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
(All numerical references in thousands, except for percentages, per share data, and number of employees)
Overview
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this Form 10-Q. Certain of the statements below contain forward-looking statements. These statements are predictions based upon our current expectations about future trends and events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. In particular, we refer you to the risks discussed in Part II, Item 1A. “Risk Factors” and in our other Securities and Exchange Commission (SEC) filings, which identify important risks and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements.
We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Form 10-Q. All subsequent written or spoken forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Form 10-Q are made only as of the date of this Form 10-Q. We do not intend, and undertake no obligation, to update these forward-looking statements.
The Company
We are a supplier of electronic design automation (EDA) systems — advanced computer software and emulation hardware systems used to automate the design, analysis, and testing of electronic hardware and embedded systems software in electronic systems and components. We market our products and services worldwide, primarily to large companies in the military/aerospace, communications, computer, consumer electronics, semiconductor, networking, multimedia, and transportation industries. Through the diversification of our customer base among these various customer markets, we attempt to reduce our exposure to fluctuations within each market. We sell and license our products through our direct sales force and a channel of distributors and sales representatives. In addition to our corporate offices in Wilsonville, Oregon, we have sales, support, software development, and professional service offices worldwide.
Business Environment
The EDA industry is highly competitive and is characterized by very strong leadership positions in specific segments of the EDA market. These strong leadership positions can be maintained for significant periods of time as the software can be difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular product. As a result, much of our profitability arises from niche areas in which we are the leader. We will continue our strategy of developing high quality tools with number one market share potential, rather than being a broad-line supplier with undifferentiated product offerings. This strategy allows us to focus investment in areas where customer needs are greatest and we have the opportunity to build significant market share.
Our products and services are dependent to a large degree on new design products initiated by customers in the integrated circuit (IC) and electronics system industries. These industries can be cyclical and are subject to rapid technological change, product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand.
Our revenue has historically fluctuated quarterly and has generally been the highest in the fourth quarter of our fiscal year due to our customers’ corporate calendar year-end spending trends and the timing of contract renewals.
Business for the first nine months of fiscal 2009 slowed from the levels achieved during fiscal 2008, with bookings down 14% compared to the first nine months of fiscal 2008. IC Design to Silicon represented 32% of bookings for the first nine months of fiscal 2009 compared to 34% for the first nine months of fiscal 2008. Bookings are the value of executed orders during a period for which revenue has been or will be recognized within six months for products and within twelve months for professional services and training. The ten largest transactions for the nine months ended October 31, 2008 accounted for approximately 38% of total system and software bookings compared to 34% for the nine months ended October 31, 2007. The number of new customers during the nine months ended October 31, 2008 was down 30% from the levels experienced during the nine months ended October 31, 2007.
Known Trends and Uncertainties Impacting Future Results of Operations: Global Market and Economic Conditions
In the U.S. and abroad, recent market and economic conditions have been unprecedented and challenging, with tighter credit conditions, increased market volatility, diminished expectations for the U.S. and global economies, and increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile
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oil prices, declining business and consumer confidence, and increased unemployment have contributed to volatility of unprecedented levels.
As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability, and the ability of our customers, to access the capital markets to meet liquidity needs and timely replace maturing liabilities, resulting in an adverse effect on our financial condition and results of operations.
License Model Mix
License model trends can have a material impact on various aspects of our business. See Note 2, “Summary of Significant Accounting Policies-Revenue Recognition” in the Notes to our condensed consolidated financial statements included in Part I, Item 1. “Financial Statements” for a description of the types of product licenses we sell. As the mix shifts among perpetual licenses, fixed term licenses (term) with upfront revenue recognition, and term licenses with revenue that is recognized over a period of time (which includes ratable due and payable and cash-based revenue recognition), revenues, earnings, cash flow, and days sales outstanding are either positively or negatively affected. The year ended January 31, 2008 marked the seventh consecutive year in which, as a percentage of product revenue, term revenue increased while perpetual license revenue decreased. This trend continued during the nine months ended October 31, 2008 and we believe this trend will continue for the remainder of fiscal 2009. Our customers continue to move toward the term license model, which provides them with greater flexibility for product usage, including the option to share products between multiple locations and remix tool use at regular intervals from a fixed product list. As such, most of our larger customers have converted their existing installed base from perpetual to term licenses.
Product Developments
During the nine months ended October 31, 2008, we continued to execute our strategy of focusing on challenges encountered by customers, as well as building upon our well-established product families. We believe that customers, faced with leading-edge design challenges in creating new products, generally choose the best EDA products in each category to build their design environment. Through both internal development and strategic acquisitions, we have focused on areas where we believe we can build a leading market position or extend an existing leading market position.
During the nine months ended October 31, 2008, we launched a number of new or improved products, which are chronologically listed below.
First Quarter
• | In February 2008, we announced the Questa® Multi-view Verification Components product and the inFact™ intelligent testbench automation tool – two new solutions that accelerate verification and improve verification coverage of today’s System on Chip (SoC) designs. |
• | In March 2008, we announced the Questa Codelink™ product, an addition to the Questa Functional Verification Platform designed to accelerate validation of application-specific integrated circuits containing one or more embedded processors. |
• | In April 2008, we announced with Agilent Technologies, Inc. a jointly developed solution that can improve productivity for the design of radio frequency circuits on printed circuit boards (PCBs). We expect the solution to cut PCB design cycle times up to half and improve the quality of mixed-technology designs. |
Second Quarter
• | In May 2008, we acquired substantially all of the assets of Ponte Solutions, Inc. (Ponte), a developer of IC design for manufacturing products. The acquisition was an investment aimed at expanding our Design-for-Manufacturing capabilities and was integrated into our Calibre® product family. |
• | In June 2008, we announced our IC implementation strategy to aid customers with the challenges of moving to smaller process nodes. This strategy included the merger of our Calibre physical verification and Design-for-Manufacturing platform, the Olympus-SoC™ place-and-route system, and our Design-for-Test and Yield Learning solution into a single Design-to-Silicon division. |
• | In June 2008, we announced that inFact™ , our award-winning intelligent testbench automation tool, has been enhanced to enable large simulations to be automatically distributed across up to 1,000 central processing units. |
• | Also in June 2008, we announced our Veloce® family of hardware-assisted verification products and the iSolve™ Multimedia product to accelerate the verification of multimedia products. |
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• | In July 2008, we announced that our virtual prototyping tool, SystemVision™, supports Design for Six Sigma methodologies to achieve cost-effective design innovation by a model-driven development process in the automotive industry. |
• | Also in July 2008, we acquired the majority of the ordinary shares of Flomerics Group, PLC (Flomerics), the market share leader in thermal analysis for electronics application and a technical leader in engineering fluid dynamics. We are integrating the acquired technology into our Mechanical Analysis products. |
Third Quarter
• | In August 2008, we announced that we are working together with Altera Corporation to develop tools and methodologies for use in creating DO-254-certifiable intellectual property. Enforced by worldwide aviation safety agencies since 2005, the DO-254 standard was developed by the avionics industry to establish design assurance and guidance for airborne electronic hardware designs. |
• | In September 2008, we announced with IBM an agreement to jointly develop and distribute next-generation computational lithography software solutions to enhance the imaging capability of lithographic systems used in the manufacturing of integrated circuits at the 22 nanometer (nm) node and beyond. |
• | Also in September 2008, we announced delivery of the industry’s first design collaboration capability between electrical and mechanical design solutions enabling teams to use this solution from the design inception to the manufacturing process, helping electronics companies reduce electro-mechanical design conflicts and develop complex products faster. |
• | In October 2008, we announced new technology in the Olympus-SoC place-and-route system that allows timing analysis and optimization tasks to run parallel and to deliver up to 7x improvement in timing analysis run times and up to 4x improvement in design closure times. |
• | Also in October 2008, we announced that we had acquired all of the outstanding shares of Flomerics. |
We believe that the development and commercialization of EDA software tools is usually a multi-year process with limited customer adoption in the first years of tool availability. Once tools are adopted, however, their life spans tend to be long. We believe that our relatively young and diverse product lines are positioned for growth over the long-term.
Financial Performance for the Nine Months Ended October 31, 2008
• | Total revenues were $184,852 for the three months ended October 31, 2008 and $546,463 for the nine months ended October 31, 2008, a decrease of 3% from the three months ended October 31, 2007 and 8% from the nine months ended October 31, 2007. The decreases for the nine month period primarily occurred in IC Design to Silicon, in our Calibre product family. |
• | System and software revenues were $97,312 for the three months ended October 31, 2008 and $289,985 for the nine months ended October 31, 2008, a decrease of 10% from the three months ended October 31, 2007 and 18% from the nine months ended October 31, 2007. Product revenue split by license model for the third quarter of fiscal 2009 was 64% term with upfront revenue recognition, 19% perpetual, and 17% term with ratable revenue recognition, which includes due and payable revenue recognition. Product revenue split by license model for the third quarter of fiscal 2008 was 60% term with upfront revenue recognition, 23% perpetual, and 17% term with ratable revenue recognition. |
• | Finance fee revenues, included in System and software revenues, were $3,507 for the three months ended October 31, 2008 and $12,435 for the nine months ended October 31, 2008, a decrease of 16% from the three months ended October 31, 2007 and consistent with the nine months ended October 31, 2007. |
• | Service and support revenues were $87,540 for the three months ended October 31, 2008 and $256,478 for the nine months ended October 31, 2008, an increase of 7% from the three and nine months ended October 31, 2007. |
• | Net loss was $78,244 for the three months ended October 31, 2008 and $120,339 for the nine months ended October 31, 2008 compared to a net loss of $8,796 for the three months ended October 31, 2007 and $6,123 for the nine months ended October 31, 2007. |
• | Trade accounts receivable, net, decreased to $243,999 as of October 31, 2008, down 27% from $332,641 as of January 31, 2008. Average days sales outstanding increased to 119 days as of October 31, 2008 from 105 days as of January 31, 2008. |
• | Cash provided by operating activities was $5,069 during the nine months ended October 31, 2008 compared to cash provided by operating activities of $20,159 for the nine months ended October 31, 2007. As of October 31, 2008, cash, cash equivalents, and short-term investments were $79,590, down 37% from $126,215 as of January 31, 2008. |
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Critical Accounting Policies
We base our discussion and analysis of our financial condition and results of operations upon our condensed consolidated financial statements which we have prepared in accordance with United States (U.S.) generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe that the accounting for revenue recognition, valuation of trade accounts receivable, valuation of deferred tax assets, income tax reserves, goodwill, intangible assets and long-lived assets, special charges, and accounting for stock-based compensation are the critical accounting estimates and judgments used in the preparation of our consolidated financial statements. For a discussion of our critical accounting policies, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended January 31, 2008.
RESULTS OF OPERATIONS
Revenues and Gross Margins
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||||||
System and software revenues | $ | 97,312 | (10 | %) | $ | 108,393 | $ | 289,985 | (18 | %) | $ | 354,162 | ||||||||||
System and software gross margin | $ | 89,936 | (11 | %) | $ | 101,548 | $ | 267,741 | (19 | %) | $ | 330,101 | ||||||||||
Gross margin percent | 92 | % | 94 | % | 92 | % | 93 | % | ||||||||||||||
Service and support revenues | $ | 87,540 | 7 | % | $ | 82,096 | $ | 256,478 | 7 | % | $ | 240,750 | ||||||||||
Service and support gross margin | $ | 63,190 | 10 | % | $ | 57,643 | $ | 182,756 | 7 | % | $ | 171,047 | ||||||||||
Gross margin percent | 72 | % | 70 | % | 71 | % | 71 | % | ||||||||||||||
Total revenues | $ | 184,852 | (3 | %) | $ | 190,489 | $ | 546,463 | (8 | %) | $ | 594,912 | ||||||||||
Total gross margin | $ | 153,126 | (4 | %) | $ | 159,191 | $ | 450,497 | (10 | %) | $ | 501,148 | ||||||||||
Gross margin percent | 83 | % | 84 | % | 82 | % | 84 | % |
System and Software
We derive System and software revenues from the sale of licenses of software products and emulation hardware systems. System and software revenues decreased in the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007 primarily in the following categories:
• | Decreases in IC Design to Silicon, primarily from our Calibre product family, partially offset by increases resulting from our Olympus-SoC place and route product; |
• | Decreases in Scalable Verification, primarily from our Emulation and 0-In® products, partially offset by increases in our ModelSim products; |
• | Decreases in Integrated Systems, primarily from our Board Station products, partially offset by our new Mechanical Analysis products; and |
• | Decreases in New and Emerging Markets, primarily from our Design-for-Test, Data Management, and Embedded Software products, partially offset by increases in our automotive cabling product revenues. |
These declines were primarily due to lower perpetual and term license revenues as a result of decreased business. Total revenues were favorably impacted by approximately 1% due to foreign currency fluctuations during the three months ended October 31, 2008 and 2% during the nine months ended October 31, 2008, as more fully described under “Geographic Revenues Information” below.
System and software revenues include finance fee revenues for the amortization of the interest component of our term license installment agreements of $3,507 for the three months ended October 31, 2008 and $12,435 for the nine months ended October 31, 2008 compared to $4,178 for the three months ended October 31, 2007 and $12,398 for the nine months ended October 31, 2007.
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System and software gross margin percentage decreased for the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007 primarily due to increased purchase technology amortization, due in large part to the acquisition of Flomerics.
The write-down of emulation hardware system inventory was $18 for the three months ended October 31, 2008 and $614 for the nine months ended October 31, 2008 compared to $73 for the three months ended October 31, 2007 and $872 for the nine months ended October 31, 2007. These reserves reduced inventory to the amount that was expected to ship within twelve months for our Veloce emulation hardware systems and six months for all other inventory on the assumption that any excess would be obsolete.
Amortization of purchased technology to System and software cost of revenues was $3,810 for the three months ended October 31, 2008 and $9,040 for the nine months ended October 31, 2008 compared to $2,139 for the three months ended October 31, 2007 and $7,513 for the nine months ended October 31, 2007. We amortize purchased technology costs over two to five years to System and software cost of revenues. The increase in amortization for the nine months ended October 31, 2008 was primarily due to the full amortization of certain purchased technology totaling $1,358 in the three months ended April 30, 2008 related to the closure of our Intellectual Property division and amortization of certain intangible assets acquired in acquisitions between February 1, 2007 and October 31, 2008. This increase for the nine months ended October 31, 2008 was partially offset by certain assets being fully amortized during the period between February 1, 2007 and October 31, 2008.
Service and Support
We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which include consulting, training, and other services. The increase in service and support revenues for the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007 was primarily due to growth in the installed base of customers under support contracts, specifically in:
• | IC Design to Silicon, primarily from our Calibre product family and our Olympus-SoC place and route product; |
• | Integrated Systems, primarily from our new Mechanical Analysis products; |
• | New and Emerging Markets, primarily from our Design-for-Test products; and |
• | Scalable Verification, primarily from our ModelSim® products. |
Professional service revenues totaled $9,766 for the three months ended October 31, 2008 and $28,099 for the nine months ended October 31, 2008 compared to $9,237 for the three months ended October 31, 2007 and $24,754 for the nine months ended October 31, 2007.
The service and support gross margin percentage increased for the three months ended October 31, 2008 compared to the three months ended October 31, 2007 primarily due to a lower cost base resulting from headcount reductions and the effect of the strengthening US dollar. Service and support gross margin percentage remained flat for the nine months ended October 31, 2008 compared to the nine months ended October 31, 2007.
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Geographic Revenues Information
Revenue by Geography
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||
North America | $ | 76,210 | (3 | %) | $ | 78,783 | $ | 212,325 | (25 | %) | $ | 284,779 | ||||||
Europe | 62,283 | 29 | % | 48,338 | 173,847 | 26 | % | 137,651 | ||||||||||
Japan | 20,709 | (43 | %) | 36,308 | 89,143 | 3 | % | 86,419 | ||||||||||
Pacific Rim | 25,650 | (5 | %) | 27,060 | 71,148 | (17 | %) | 86,063 | ||||||||||
Total revenue | $ | 184,852 | (3 | %) | $ | 190,489 | $ | 546,463 | (8 | %) | $ | 594,912 | ||||||
Revenues decreased in North America for the three months ended October 31, 2008 compared to the three months ended October 31, 2007 primarily due to decreased emulation hardware product revenues, partially offset by increased software product revenues. Revenues decreased in North America for the nine months ended October 31, 2008 compared to the nine months ended October 31, 2007 primarily due to decreased software product revenues and emulation hardware product revenues.
Revenues outside of North America represented 59% of total revenues for the three months ended October 31, 2008 and 61% for the nine months ended October 31, 2008 compared to 59% for the three months ended October 31, 2007 and 52% for the nine months ended October 31, 2007. For the three and nine months ended October 31, 2008 and 2007, approximately one-fourth of European revenues were booked in local currencies and subject to exchange rate fluctuations. The effects of exchange rate differences from the European currencies to the U.S. dollar favorably impacted European revenues by approximately 2% for the three and nine months ended October 31, 2008. Exclusive of currency effects, higher European revenues for the three and nine months ended October 31, 2008 were primarily due to increased software product revenues and support revenues.
Approximately ninety-five percent of Japanese revenues were recorded in Japanese yen during the three months ended October 31, 2008 and approximately ninety percent of Japanese revenues were recorded in Japanese yen during the nine months ended October 31, 2008. Substantially all Japanese revenues were recorded in Japanese yen during the three and nine months ended October 31, 2007. The effects of exchange rate differences from the Japanese yen to the U.S. dollar favorably impacted Japanese revenues by approximately 7% for the three months ended October 31, 2008 and 11% for the nine months ended October 31, 2008. Exclusive of currency effects, lower Japanese revenues for the three months ended October 31, 2008 were primarily due to decreased software product revenues. Exclusive of currency effects, Japanese revenues were lower for the nine months ended October 31, 2008 primarily due to decreased software product revenues and emulation hardware product revenues.
Revenues decreased in the Pacific Rim for the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007, primarily due to decreased software product revenues, partially offset by increased support revenues.
We generate more than half of our revenues outside of North America and expect this to continue in the future. Revenue results will continue to be impacted by future foreign currency fluctuations.
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Operating Expenses
Three Months Ended October 31, | Nine Months Ended October 31, | |||||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||||
Research and development | $ | 65,146 | 2 | % | $ | 63,706 | $ | 193,779 | 3 | % | $ | 187,628 | ||||||||
Marketing and selling | 76,688 | 3 | % | 74,580 | 226,135 | 2 | % | 222,279 | ||||||||||||
General and administration | 24,333 | 1 | % | 24,183 | 71,493 | 1 | % | 71,080 | ||||||||||||
Other general expense (income), net | 168 | (6 | %) | 178 | (269 | ) | 608 | % | (38 | ) | ||||||||||
Amortization of intangible assets | 3,129 | 16 | % | 2,704 | 8,099 | 27 | % | 6,361 | ||||||||||||
Special charges | 2,214 | 99 | % | 1,115 | 15,099 | 193 | % | 5,160 | ||||||||||||
In-process research and development | 6,790 | — | — | 22,075 | 438 | % | 4,100 | |||||||||||||
Total operating expenses | $ | 178,468 | 7 | % | $ | 166,466 | $ | 536,411 | 8 | % | $ | 496,570 | ||||||||
Research and Development
For the three months ended October 31, 2008 compared to the three months ended October 31, 2007, the increase in research and development costs was primarily due to:
• | The acquisition of Flomerics in the second quarter of fiscal 2009; |
• | The year-over-year effect of increases in annual salary costs; and |
• | Increased stock based compensation under Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)). |
These increases were partially offset by:
• | Decreased variable compensation; |
• | An increase in research and development credits to offset costs incurred in France; |
• | Decreased travel costs; |
• | Increased non-recurring engineering reimbursements from work performed; and |
• | A strengthening of the U.S. dollar. |
The increase in research and development credits were due to changes in the calculations of credits as further discussed in Note 4, “Change in Accounting for Research and Development Credits” in the Notes to our condensed consolidated financial statements included in Part I, Item 1. “Financial Statements.”
For the nine months ended October 31, 2008 compared to the nine months ended October 31, 2007, the increase in research and development costs was primarily due to:
• | The year-over-year effect of increases in annual salary costs; |
• | The acquisition of Sierra Design Automation, Inc. (Sierra) in the second quarter of fiscal 2008; |
• | Increased stock based compensation under SFAS 123(R); |
• | The acquisition of Flomerics in the second quarter of fiscal 2009; and |
• | Increased telecom, outside services, and facility costs. |
These increases were partially offset by:
• | Decreased variable compensation; |
• | A strengthening of the U.S. dollar; |
• | An increase in research and development credits to offset costs incurred in France; |
• | Decreased travel costs; and |
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• | Increased non-recurring engineering reimbursements from work performed. |
Marketing and Selling
For the three months ended October 31, 2008 compared to the three months ended October 31, 2007, the increase in marketing and selling costs was primarily due to the acquisition of Flomerics in the second quarter of fiscal 2009 and increased stock based compensation under SFAS 123(R). These increases were partially offset by decreased variable compensation and a strengthening of the U.S. dollar.
For the nine months ended October 31, 2008 compared to the nine months ended October 31, 2007, the increase in marketing and selling costs was primarily due to:
• | The year-over-year effect of increases in annual salary costs; |
• | The acquisition of Sierra in the second quarter of fiscal 2008; |
• | The acquisition of Flomerics in the second quarter of fiscal 2009; and |
• | Increased stock based compensation under SFAS 123(R). |
These increases were partially offset by:
• | Decreased variable compensation; |
• | A strengthening of the U.S. dollar; |
• | Decreased marketing and advertising costs; and |
• | Decreased travel costs. |
General and Administration
For the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007, general and administration costs were relatively flat as decreases in variable compensation were offset by increases in stock-based compensation under SFAS 123(R), increased costs resulting from the acquisition of Sierra in the second quarter of fiscal 2008 and increased costs resulting from the acquisition of Flomerics in the second quarter of fiscal 2009.
Other General Expense (Income), Net
Other general expense (income), net represents the net gain on the sale of qualifying receivables to certain financing institutions on a non-recourse basis. The gain on the sale of long-term receivables consists of two components: (i) the difference between the gross balance of the receivables and the net proceeds received from the financing institution, referred to as the discount on sold receivables and (ii) interest income representing the unaccreted discount on the receivables, which is recognized once the receivables are sold.
The discount on sold receivables was $397 during the three months ended October 31, 2008 and $2,135 during the nine months ended October 31, 2008 compared to $2,362 during the three months ended October 31, 2007 and $3,222 during the
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nine months ended October 31, 2007. The interest income recognized on sold receivables was $229 during the three months ended October 31, 2008 and $2,404 during the nine months ended October 31, 2008 compared to $2,184 during the three months ended October 31, 2007 and $3,260 during the nine months ended October 31, 2007. These decreases were due to a decrease in the overall sale of receivables, which resulted in lower unaccreted interest income on the receivables at the time of sale. This was partially affected by lower discount rates applied to sold receivables during the nine months ended October 31, 2008 compared to the nine months ended October 31, 2007.
Amortization of Intangible Assets
For the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007, the increase in amortization of intangible assets was primarily due to amortization of certain intangible assets acquired in acquisitions between February 1, 2007 and October 31, 2008. This increase is partially offset by certain assets being fully amortized during the period between February 1, 2007 and October 31, 2008.
Special Charges
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||||
Employee severance and related costs | $ | 350 | (69 | %) | $ | 1,115 | $ | 9,194 | 59 | % | $ | 5,798 | ||||||||
Excess leased facility costs | (409 | ) | — | — | 2,547 | 446 | % | (737 | ) | |||||||||||
Other costs | 2,273 | — | — | 3,358 | 3,292 | % | 99 | |||||||||||||
Total special charges | $ | 2,214 | 99 | % | $ | 1,115 | $ | 15,099 | 193 | % | $ | 5,160 | ||||||||
We recorded special charges of $2,214 during the three months ended October 31, 2008 and $15,099 during the nine months ended October 31, 2008. The charges for the three months ended October 31, 2008 primarily consisted of advisory fees incurred in response to the unsolicited offer by Cadence Design Systems, Inc. (Cadence) to acquire us. The charges for the nine months ended October 31, 2008 primarily consisted of costs incurred for employee terminations and were due to our reduction of personnel resources driven by modifications of business strategy or business emphasis.
We rebalanced our workforce by 6 employees during the three months ended October 31, 2008 and 136 employees during the nine months ended October 31, 2008. The reduction impacted several employee groups. Employee severance costs of $350 during the three months ended October 31, 2008 and $9,194 during the nine months ended October 31, 2008 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans, none of which was individually material to our financial position or results of operations. We determined the termination benefit amount based on employee status, years of service, and local statutory requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge. Approximately 77% of these costs were paid during the nine months ended October 31, 2008. We expect to pay the remainder during the fiscal year ending January 31, 2009. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $(409) during the three months ended October 31, 2008 and $2,547 during the nine months ended October 31, 2008 were primarily due to the abandonment of six leased facilities and changes in the estimate of sublease income for previously abandoned leased facilities.
Other special charges of $2,273 during the three months ended October 31, 2008 consisted of advisory fees incurred in response to the unsolicited offer by Cadence to acquire us. Other special charges of $3,358 during the nine months ended October 31, 2008 included costs of $3,345 related to advisory fees incurred in response to the unsolicited offer by Cadence to acquire us, costs of $93 related to the closure of a division, and other charges of $(80).
We recorded special charges of $1,115 during the three months ended October 31, 2007 and $5,160 during the nine months ended October 31, 2007. These charges primarily consisted of costs incurred for employee terminations and were due to our reduction of personnel resources driven by modifications of business strategy or business emphasis.
We rebalanced our workforce by 22 employees during the three months ended October 31, 2007 and 138 employees during the nine months ended October 31, 2007. The reduction impacted several employee groups. Employee severance costs of $1,115 during the three months ended October 31, 2007 and $5,798 during the nine months ended October 31, 2007 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans, none of which was individually material to our financial position or results of operations. We determined the termination benefit amount based on employee status, years of service, and local statutory requirements. We communicated termination benefits to the affected employees prior to the end of the quarter in which we recorded the charge.
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Substantially all of these costs were paid during the fiscal year ended January 31, 2008. There have been no significant modifications to the amount of these charges.
The reduction of excess leased facility costs of $737 during the nine months ended October 31, 2007 resulted from the re-occupancy of a previously abandoned leased facility in the second quarter of fiscal 2008 and the termination of an abandoned facility lease in a lease buyout in the first quarter of fiscal 2008. The cost of the lease buyout was less than the remaining balance of the accrual, resulting in an adjustment to special charges.
In-process Research and Development
Three months ended October 31, | Nine months ended October 31, | ||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | ||||||||||||
In-process research and development | $ | 6,790 | — | $ | — | $ | 22,075 | 438 | % | $ | 4,100 |
In-process research and development of $6,790 for the three months ended October 31, 2008 is a result of the Flomerics acquisition and is specifically assigned to three projects: Next Generation FLOTHERM, Next Generation FLOVENT, and Next Generation MicReD.
In-process research and development of $22,075 for the nine months ended October 31, 2008 includes $1,300 from the Ponte acquisition assigned to one project, Litho-Etch, $6,790 from the Flomerics acquisition as previously discussed and $13,985 resulting from undeveloped technology acquired through a joint development agreement addressing technological challenges of IC design at 22 nm geometries. The total acquired in-process research and development of $4,100 for the nine months ended October 31, 2007 was assigned entirely to one project, Next Generation Pinnacle, resulting from the Sierra acquisition.
We based the value of the Flomerics in-process research and development on the excess earnings method which measures the value of an asset by calculating the present value of related future economic benefits, such as cash earnings. In determining the value of the in-process research and development, the assumed commercialization date is fiscal 2011 for Next Generation MicReD and fiscal 2012 for Next Generation FLOTHERM and Next Generation FLOVENT. The modeled cash flow was discounted back to net present value and was based on estimates of revenue and operating profits related to the projects. Significant assumptions used in the valuation of the Flomerics in-process research and development included: stage of development of the projects, future revenues, estimated life of the products’ underlying technology, future operating expenses, and a discount rate of 22% to reflect present value and the risk associated with the development of technology.
We based the value of the Ponte in-process research and development on the excess earnings method. In determining the value of this in-process research and development, the assumed commercialization date for the product was the fourth quarter of fiscal 2009. The modeled cash flow was discounted back to net present value and was based on estimates of revenues and operating profits related to the project. Significant assumptions used in the valuation of this in-process research and development included: stage of development of the project, future revenues, estimated life of the product’s underlying technology, future operating expenses, and a discount rate of 18% to reflect present value and the risk associated with the development of technology.
These estimates are subject to change, given the uncertainties of the development process, and no assurance can be given that deviations from these estimates will not occur or that we will realize any anticipated benefits of the acquisitions. The risks associated with the acquired research and development are considered high, and no assurance can be made that any resulting products will generate any benefit or meet market expectations.
We based the value of the undeveloped technology acquired through the 22 nm joint development agreement on the present value of the four year payment stream as defined in the agreement. The joint development agreement provides access to technology which has not yet reached technological feasibility and provides no alternative future use. The technology is expected to be the basis for a new offering in the Calibre product family once development is completed. The product release date has yet to be determined. The risks associated with the in-process research and development are considered high and no assurance can be made that any resulting products will generate any benefit or meet market expectations.
The fee related to the development agreement includes guaranteed payments of $2,500 during fiscal 2009, $5,000 during fiscal 2010, and annual payments of $2,500 during each of fiscal 2011 through fiscal 2013.
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Other Income, Net
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||||||
Interest income | $ | 1,099 | (33 | %) | $ | 1,631 | $ | 4,013 | (26 | %) | $ | 5,456 | ||||||||||
Gain (loss) on hedge ineffectiveness | (89 | ) | (1,213 | %) | 8 | (75 | ) | (3,850 | %) | 2 | ||||||||||||
Foreign currency exchange gain (loss) | 1,286 | 471 | % | (347 | ) | 2,397 | 369 | % | (891 | ) | ||||||||||||
Equity in losses of unconsolidated entities | (445 | ) | — | — | (1,088 | ) | — | — | ||||||||||||||
Other, net | (157 | ) | 41 | % | (266 | ) | (550 | ) | 9 | % | (606 | ) | ||||||||||
Other income, net | $ | 1,694 | 65 | % | $ | 1,026 | $ | 4,697 | 19 | % | $ | 3,961 | ||||||||||
The decline in interest income for the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007 was primarily due to lower interest income earned on our cash, cash equivalents, and short-term investments, partially offset by increased interest income for the time value of foreign currency contracts.
We recognized a loss of $89 for the three months ended October 31, 2008 and a loss of $75 for the nine months ended October 31, 2008 resulting from the ineffectiveness of derivative instruments that met the criteria for hedge accounting treatment under the requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” compared to a gain of $8 for the three months ended October 31, 2007 and a gain of $2 for the nine months ended October 31, 2007.
The improvements of foreign currency exchange gain (loss) for the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007 were primarily due to the favorable movement of exchange rates on the U.S. dollar.
We recognized a loss of $445 for the three months ended October 31, 2008 and a loss of $1,088 for the nine months ended October 31, 2008 which represented our portion on losses of an unconsolidated entity accounted for under the equity method.
Interest Expense
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||
Interest expense | $ | 4,270 | (15 | %) | $ | 5,053 | $ | 12,230 | (19 | %) | $ | 15,112 |
For the three and nine months ended October 31, 2008 compared to the three and nine months ended October 31, 2007, the decrease in interest expense was due largely to the purchase and retirement during fiscal 2008 of $13,748 of the Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023 and $35,000 of the 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026.
Provision for Income Taxes
Three months ended October 31, | Nine months ended October 31, | |||||||||||||||||||
2008 | Change | 2007 | 2008 | Change | 2007 | |||||||||||||||
Income tax expense (benefit) | $ | 50,369 | (2,110 | %) | $ | (2,506 | ) | $ | 27,024 | (6,105 | %) | $ | (450 | ) |
We recorded an income tax expense of $50,369 for the three months ended October 31, 2008 and $27,024 for the nine months ended October 31, 2008 compared to an income tax benefit of $2,506 for the three months ended October 31, 2007 and $450 for the nine months ended October 31, 2007. Generally, the provision for income taxes is the result of the mix of profits (losses) earned by us and our subsidiaries in tax jurisdictions with a broad range of income tax rates, withholding taxes (primarily in certain foreign jurisdictions), changes in tax reserves, and the application of valuation allowances. On a quarterly basis, we evaluate our provision for income tax expense (benefit) based on our projected results of operations for the full year and record an adjustment in the current quarter. For the nine months ended October 31, 2008, our effective tax rate was (29%), after considering discrete items totaling $177 of tax expense. Our effective tax rate for the nine months ended October 31, 2008 without discrete items was also (29%). We expect tax expense in fiscal year 2009 even though we expect a loss on our income statement for the full fiscal year. This is because, in significant part, we have net profits in our international operations and a loss in the U.S. The tax benefit of the U.S. financial reporting loss is expected to be offset by an increase in the valuation allowance on U.S. deferred tax assets. The effect of these circumstances is to create a negative
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tax rate both in the three and nine months ended October 31, 2008. For fiscal 2009, we project a (31%) effective tax rate, after the inclusion of discrete items. This differs from tax computed at the U.S. federal statutory rate primarily due to:
• | Projected losses in the U.S. for which no tax benefit will be recognized; |
• | Non-deductible incentive stock option and employees stock purchase plan compensation expense; |
• | Withholding taxes in certain foreign jurisdictions; and |
• | Increases in foreign tax reserves. |
These differences are offset by:
• | The benefit of lower tax rates on earnings of foreign subsidiaries; and |
• | The application of tax incentives for research and development in certain jurisdictions. |
Our current projected tax rate for fiscal 2009 of (31%) decreased from 46% projected as of the end of the second quarter of fiscal 2009 primarily as a result of the change in projected earnings. The effective tax rate for the remainder of fiscal 2009 could change significantly if actual results are different than current outlook-based projections. We have not provided for U.S. income taxes on the undistributed earnings of foreign subsidiaries because they are considered permanently re-invested outside of the U.S. If repatriated, some of these earnings would generate foreign tax credits, which may reduce the federal tax liability associated with any future foreign dividend.
Under SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), we determined deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities. We then measured the difference using the enacted tax rates and laws that will be in effect when we expect differences to reverse. SFAS 109 provides for the recognition of deferred tax assets without a valuation allowance if realization of such assets is more likely than not. Since 2004, we have determined it is uncertain whether our U.S. entity will generate sufficient taxable income and foreign source income to utilize foreign tax credit carryforwards, research and experimentation credit carryforwards, and net operating loss carryforwards before expiration. Accordingly, we recorded valuation allowances in fiscal 2008 against the portion of those deferred tax assets for which realization is not more likely than not. We expect to continue applying valuation allowances in fiscal 2009, to the extent net deferred tax assets are generated, consistent with prior years. A portion of the valuation allowances for deferred tax assets relates to certain of the tax attributes acquired from IKOS Systems, Inc. in 2002 and 0-In Design Automation, Inc. in 2004 for which subsequently recognized tax benefits will be applied directly to reduce goodwill. Valuation allowances relating to non-U.S. taxing jurisdictions were based on the historical earnings patterns which indicated uncertainty that we will have sufficient income in the appropriate jurisdictions to realize the full value of the assets. We will continue to evaluate the realizability of the deferred tax assets on a periodic basis.
We are subject to income taxes in the U.S. and in numerous foreign jurisdictions in the ordinary course of business and, as a result, there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to our historic tax obligations will vary from jurisdiction to jurisdiction. In some cases it may be extended or be unlimited. Furthermore, attribute carryforwards may be subject to adjustment after the expiration of the statute of limitations of the year such attribute was originated. Our larger jurisdictions generally provide for a statute of limitations from three to five years. In the U.S., the statute of limitations remains open for fiscal years 2002 and forward. We are currently under examination in various jurisdictions, including the U.S. The examinations are in different stages and timing of their resolution is difficult to predict. The examination in the U.S. by the Internal Revenue Service (IRS) pertains to our 2002, 2003, 2004, 2005, and 2006 tax years. In March 2007, the IRS issued a Revenue Agent’s Report for 2002 through 2004 in which adjustments were asserted totaling $146,600 of additional taxable income. The adjustments primarily concern transfer pricing arrangements related to intellectual property rights acquired in acquisitions which were transferred to a foreign subsidiary. While we continue to be in the process of contesting the adjustments with the Appeals Office of the IRS, we have reached a tentative settlement. The settlement is generally consistent with our reserve posture, and due to our valuation allowance position in the U.S. we do not expect any significant financial statement impact once this matter is effectively settled. Our statute of limitations remains open for years on and after 2003 in Ireland and 2004 in Japan.
We have reserves for potential tax liabilities to address potential exposures involving tax positions that are being challenged or that could be challenged by taxing authorities even though we believe the positions we have taken are appropriate. We believe our tax reserves are adequate to cover potential liabilities. We review the tax reserves as circumstances warrant and adjust the reserves as events occur that affect our potential liability for additional taxes. It is often difficult to predict the final outcome or timing of resolution of any particular tax matter; and various events, some of which cannot be predicted, such as
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clarifications of tax law by administrative or judicial means, may occur and would require us to increase or decrease our reserves and effective tax rate. In our financial results for the current period, we have included a gross increase in unrecognized tax benefits as a result of tax positions taken during a prior year of approximately $4,343. Further, we have recorded additional reserves in the nine months ended October 31, 2008, and expect to record additional reserves in future periods, with respect to tax positions taken for the current year; however, it is reasonably possible that reserves for prior years’ tax positions will decrease by a range of $0 to $18,000 due to settlements or expirations of the statute of limitations within the next twelve months. Uncertain tax positions that resolve in our favor will have a positive impact on our effective tax rate, except to the extent such resolution results in a reduction to goodwill or the booking of deferred tax assets subject to a valuation allowance. Certain reductions in our reserves may require cash payments. Please refer to “Liquidity and Capital Resources” in this Item 2. for additional discussion. Accrued tax-related interest and penalties were $331 for the three months ended October 31, 2008 and $3,112 for the nine months ended October 31, 2008.
Effects of Foreign Currency Fluctuations
We generated nearly two-thirds of our revenues and approximately one-third of our expenses outside of the U.S. for the three and nine months ended October 31, 2008 compared to approximately half of our revenues and approximately one-third of our expenses for the three and nine months ended October 31, 2007. For the three and nine months ended October 31, 2008 and 2007, approximately one-fourth of European revenues were subject to exchange rate fluctuations, as they were booked in local currencies. For the three months ended October 31, 2008, approximately ninety-five percent of Japanese revenues were subject to exchange rate fluctuations compared to almost all Japanese revenues for the three months ended October 31, 2007. For the nine months ended October 31, 2008, approximately ninety percent of Japanese revenues were subject to exchange rate fluctuations compared to substantially all Japanese revenues for the nine months ended October 31, 2007. Most large European revenue contracts are denominated and paid to us in the U.S. dollar while our European expenses, including substantial research and development operations, are paid in local currencies causing a short position in the euro and the British pound. In addition, we experience greater inflows than outflows of Japanese yen as almost all Japanese-based customers contract and pay us in Japanese yen. While these exposures are aggregated on a consolidated basis to take advantage of natural offsets, substantial exposure remains.
For exposures that are not offset, we enter into short-term foreign currency forward and option contracts to partially offset these anticipated exposures. We generally enter into option contracts at contract strike rates that are different than current market rates. As a result, any unfavorable currency movements below the strike rates will not be offset by the foreign currency option contract and could negatively affect operating results. These contracts address anticipated future cash flows for periods up to one year and do not hedge 100% of the potential exposures related to these currencies. As a result, the effects of currency fluctuations could have a substantial effect on our overall results of operations.
Foreign currency translation adjustment, a component of Accumulated other comprehensive income reported in the Stockholders’ equity section of our Condensed Consolidated Balance Sheets, decreased to $19,762 as of October 31, 2008 from $37,782 as of January 31, 2008. This decrease reflects the decrease in the value of net assets denominated in foreign currencies as a result of the strengthening of the U.S. dollar since January 31, 2008.
LIQUIDITY AND CAPITAL RESOURCES
As of | ||||||||
October 31, 2008 | January 31, 2008 | |||||||
Current assets | $ | 372,797 | $ | 506,481 | ||||
Cash, cash equivalents, and short-term investments | $ | 79,590 | $ | 126,215 | ||||
Nine months ended October 31, | ||||||||
2008 | 2007 | |||||||
Cash provided by operating activities | $ | 5,069 | $ | 20,159 | ||||
Cash used in investing activities, excluding short-term investments | $ | (88,335 | ) | $ | (67,353 | ) | ||
Cash provided by financing activities | $ | 40,126 | $ | 4,903 |
Cash, Cash Equivalents, and Short-Term Investments
Cash provided by operating activities for the nine months ended October 31, 2008 was $5,069 compared to $20,159 for the nine months ended October 31, 2007. The decrease in cash flows from operating activities was primarily due to an increase in Net loss, partially offset by a change in Trade accounts receivable.
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We have entered into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. For the nine months ended October 31, 2008, we sold trade receivables of $21,580 and term receivables of $22,311 for net proceeds of $41,757. For the nine months ended October 31, 2007, we sold trade receivables of $19,778 and term receivables of $24,620 for net proceeds of $41,177. We continue to evaluate the economics of the sale of accounts receivable and do not have a set target for the sale of accounts receivable for the remainder of fiscal 2009.
Excluding short-term investments, cash used in investing activities for the nine months ended October 31, 2008 primarily consisted of cash paid for the acquisition of businesses and equity interests of $54,485 and capital expenditures of $33,850. Cash paid for acquisitions of business and equity interests included:
• | $50,531 paid for the acquisition of businesses; |
• | $2,454 paid for earn-outs related to prior-year acquisitions; and |
• | $1,500 paid for equity interests in unconsolidated entities. |
Excluding short-term investments, cash used in investing activities for the nine months ended October 31, 2007 included:
• | $35,909 paid for the acquisition of businesses; |
• | $29,308 paid for capital expenditures; and |
• | $2,136 paid for earn-outs related to prior-year acquisitions. |
Cash provided by financing activities for the nine months ended October 31, 2008 included:
• | $30,000 provided by our revolving credit facility as further discussed below; |
• | Common stock issuances of $14,565 for stock option exercises; and |
• | $4,464 used for net repayments of short-term borrowings. |
Cash provided by financing activities for the nine months ended October 31, 2007 included:
• | Common stock issuances of $17,547 for stock option exercises; |
• | $10,899 used for the repurchase of Notes payable, as more fully described in “Capital Resources”; and |
• | $1,745 used for the net repayments of short-term borrowings. |
Trade Accounts and Term Receivables
As of | ||||||
October 31, 2008 | January 31, 2008 | |||||
Trade accounts receivable, net | $ | 243,999 | $ | 332,641 | ||
Term receivables, long-term | $ | 124,791 | $ | 134,059 | ||
Average days sales outstanding in trade accounts receivable | 119 days | 105 days | ||||
Average days sales outstanding in trade accounts receivable, excluding current portion of term receivables | 55 days | 55 days |
Trade Accounts Receivable, Net
The increase in the average days sales outstanding in trade accounts receivable was primarily due to decreased revenue in our perpetual and term arrangements for the three months ended October 31, 2008 compared to the three months ended January 31, 2008. This increase is partially offset by improved collections of trade accounts receivable for the three months ended October 31, 2008 compared to the three months ended January 31, 2008.
Excluding the current portion of term receivables of $131,731 as of October 31, 2008 and $157,077 as of January 31, 2008, average days sales outstanding were 55 as of October 31, 2008 and January 31, 2008.
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Term Receivables, Long-Term
The balance is attributable to multi-year term license sales agreements. We include amounts for term agreements that are due within one year in Trade accounts receivable, net, and balances that are due in more than one year in Term receivables, long-term. We use term agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. The decrease from January 31, 2008 was primarily due to decreased revenue in our term agreements for the three months ended October 31, 2008 compared to the three months ended January 31, 2008.
Property, Plant, and Equipment, net
As of | ||||||
October 31, 2008 | January 31, 2008 | |||||
Property, plant, and equipment, net | $ | 106,063 | $ | 100,421 |
The increase in Property, plant, and equipment, net was due to normal capital purchases, offset by depreciation and disposals. The increase did not include any individually significant projects and was primarily due to infrastructure improvements within facilities and information technology. In addition, the acquisition of Flomerics included property, plant, and equipment that contributed to the overall increase.
Accrued Payroll and Related Liabilities
As of | ||||||
October 31, 2008 | January 31, 2008 | |||||
Accrued payroll and related liabilities | $ | 54,032 | $ | 78,948 |
The decrease in Accrued payroll and related liabilities primarily reflects the payment of annual bonus and sales commission accruals offset by incremental accruals for annual bonuses and sales commissions for the nine months ended October 31, 2008. Accruals for bonuses were lower as of October 31, 2008 compared to January 31, 2008 due to seasonality in our business, which generally results in higher bonus accruals at the end of our fiscal year. The sales commission accruals were lower as of October 31, 2008 compared to January 31, 2008 due to lower revenues in the three months ended October 31, 2008 compared to the three months ended January 31, 2008.
Deferred Revenue
As of | ||||||
October 31, 2008 | January 31, 2008 | |||||
Deferred revenue | $ | 150,282 | $ | 173,798 |
Deferred revenue consists primarily of prepaid annual software support services. The decrease in deferred revenue was primarily due to normal amortization of prepayments on existing contracts during the period. The decrease is partially offset by the addition of deferred revenues from billings during fiscal 2009 and the acquisition of Flomerics in the second quarter of fiscal 2009.
Income Taxes
As of October 31, 2008, we had a net liability of approximately $53,689 for income taxes associated with uncertain income tax positions. All of these liabilities are classified as long-term liabilities in our Condensed Consolidated Balance Sheet, as we generally do not anticipate the settlement of the liabilities will require payment of cash within the next twelve months. Further, certain liabilities may result in the reduction of deferred tax assets rather than settlement in cash. We are not able to reasonably estimate the timing of any cash payments required to settle these liabilities and do not believe that the ultimate settlement of these obligations will materially affect our liquidity.
Capital Resources
Expenditures for property, plant, and equipment increased to $33,850 for the nine months ended October 31, 2008 compared to $29,308 for the nine months ended October 31, 2007. We expect expenditures for property, plant, and equipment for fiscal 2009 will be approximately $39,000 compared to $38,000 for fiscal 2008.
In July 2008, we acquired Flomerics which resulted in a net cash payment of $44,885. The cash payment for the acquisition of Flomerics was net of $12,411 of cash held by Flomerics and acquired by us in the transaction. In May 2008, we acquired substantially all of the assets of Ponte for a net cash payment of $5,646. The cash payment for the acquisition of the Ponte
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assets was net of $39 of cash held by Ponte and acquired by us in the transaction. Additionally, during the nine months ended October 31, 2008, we paid $2,454 for earn-outs related to prior acquisitions.
As a result of the acquisition of undeveloped 22 nm technology we acquired under a joint development agreement entered into during the second quarter of fiscal 2009, we are required to make payments of $2,500 during fiscal 2009, $5,000 during fiscal 2010, and annual payments of $2,500 during each of fiscal 2011 through fiscal 2013. Of the $2,500 due in fiscal 2009, we paid $1,250 during the three months ended October 31, 2008. See further discussion of the joint development agreement in Note 18, “In-Process Research and Development” in the Notes to our condensed consolidated financial statements included in Part I, Item 1. “Financial Statements.”
In June 2007, we acquired Sierra which resulted in a net cash payment of $35,271, net of cash held by Sierra of $9,716 and acquired by us in the transaction. In March 2007, we acquired the technology of Dynamic Soft Analysis, Inc. which resulted in a net cash payment of $638. Additionally, during the nine months ended October 31, 2007, we paid $2,136 for earn-outs related to prior acquisitions.
In March 2006, we issued $200,000 of 6.25% Debentures in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the 6.25% Debentures is payable semi-annually in March and September. The 6.25% Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $17.968 per share for a total of 9,183 shares as of October 31, 2008. These circumstances generally include:
• | The market price of our common stock exceeding 120% of the conversion price; |
• | The market price of the 6.25% Debentures declining to less than 98% of the value of the common stock into which the 6.25% Debentures are convertible; |
• | A call for the redemption of the 6.25% Debentures; |
• | Specified distributions to holders of our common stock; |
• | If a fundamental change, such as a change of control, occurs; or |
• | During the ten trading days prior to, but not on, the maturity date. |
Upon conversion, in lieu of shares of our common stock, for each $1 principal amount of the 6.25% Debentures a holder will receive an amount of cash equal to the lesser of: (i) $1 or (ii) the conversion value of the number of shares of our common stock equal to the conversion rate. If such conversion value exceeds $1, we will also deliver, at our election, cash or common stock, or a combination of cash and common stock with a value equal to the excess. If a holder elects to convert their 6.25% Debentures in connection with a fundamental change in the company that occurs prior to March 6, 2011, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances. The 6.25% Debentures rank pari passu with the Floating Rate Debentures. We may redeem some or all of the 6.25% Debentures for cash on or after March 6, 2011. The holders, at their option, may redeem some or all of the 6.25% Debentures for cash on March 1, 2013, 2016, or 2021. During the nine months ended October 31, 2008, we did not repurchase any 6.25% Debentures and the principal amount of $165,000 remains outstanding.
In August 2003, we issued $110,000 of Floating Rate Debentures in a private offering pursuant to SEC Rule 144A under the Securities Act of 1933. Interest on the Floating Rate Debentures is payable quarterly in February, May, August, and November at a variable interest rate equal to 3-month LIBOR plus 1.65%. The effective interest rate was 4.60% for the nine months ended October 31, 2008 and 7.01% for the nine months ended October 31, 2007. The Floating Rate Debentures are convertible, under certain circumstances, into our common stock at a conversion price of $23.40 per share for a total of 1,543 shares as of October 31, 2008. These circumstances generally include:
• | The market price of our common stock exceeding 120% of the conversion price; |
• | The market price of the Floating Rate Debentures declining to less than 98% of the value of the common stock into which the Floating Rate Debentures are convertible; or |
• | A call for redemption of the Floating Rate Debentures or certain other corporate transactions. |
The conversion price may also be adjusted based on certain future transactions, such as stock splits or stock dividends. We may redeem some or all of the Floating Rate Debentures for cash at 101.61% of the face amount, with the premium reducing to 0.81% on August 6, 2009 and 0% on August 6, 2010. The holders, at their option, may redeem some or all of the Floating Rate Debentures for cash on August 6, 2010, 2013, or 2018. During the nine months ended October 31, 2008, we did not repurchase any Floating Rate Debentures and the principal amount of $36,102 remains outstanding.
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During the nine months ended October 31, 2007, we purchased on the open market and retired Floating Rate Debentures with a principal balance of $10,898, for a total purchase price of $11,169. In connection with this purchase, we incurred a before tax net loss on the early extinguishment of debt of $452, which included a $271 premium on the repurchased Floating Rate Debentures as well as the write-off of $181 of unamortized deferred debt issuance costs.
We may elect to purchase or otherwise retire some or all of the debentures with cash, stock, or other assets from time to time in the open market or privately negotiated transactions, either directly or through intermediaries, or by tender offer when we believe that market conditions are favorable to do so. Such purchases may have a material effect on our liquidity, financial condition, and results of operations.
In June 2005, we entered into a syndicated, senior, unsecured, four-year revolving credit facility that replaced an existing three-year revolving credit facility. In April 2008, we extended this revolving credit facility by two years to June 1, 2011. In May 2008, we increased the maximum borrowing capacity from $120,000 to $140,000 and retained an option to increase it by an additional $10,000 in the future. Under this revolving credit facility, we have the option to pay interest based on: (i) LIBOR with varying maturities which are commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) prime plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. As a result, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.25% and 0.35% based on a pricing grid tied to a financial covenant. We paid commitment fees of $89 for the three months ended October 31, 2008 and $259 for the nine months ended October 31, 2008 compared to $77 for the three months ended October 31, 2007 and $228 for the nine months ended October 31, 2007. This revolving credit facility contains certain financial and other covenants, including financial covenants requiring the maintenance of specified liquidity ratios, leverage ratios, and minimum tangible net worth as well as restrictions on the payment of cash dividends. We borrowed $30,000 against the revolving credit facility with a 4.00% interest rate during the three and nine months ended October 31, 2008. We had no borrowings during the three and nine months ended October 31, 2007 against this facility. As of October 31, 2008, we had an outstanding balance of $30,000. As of January 31, 2008, we had no outstanding balance against this revolving credit facility.
As of October 31, 2008, we had cash and cash equivalents of $77,593. The available cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our operating accounts. The invested cash is invested in interest bearing funds managed by third party financial institutions and in direct obligations of the U.S. government. To date, we have experienced no loss or lack of access to our cash or cash equivalents; however, we can provide no assurances that access to our cash and cash equivalents will not be impacted by adverse conditions in the financial markets.
At any point in time, we have significant balances in operating accounts that are with individual third party financial institutions, which exceed the Federal Deposit Insurance Corporation insurance limits or other regulatory insurance program limits. While we monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or could be subject to other adverse conditions in the financial markets. To date, we have experienced no loss or lack or access to cash in our operating accounts.
Our primary ongoing cash requirements will be for product development, operating activities, capital expenditures, debt service, and acquisition opportunities that may arise. Our primary sources of liquidity are cash generated from operations and borrowings under the revolving credit facility. We anticipate that the following will be sufficient to meet our working capital needs on a short-term and long-term basis:
• | Current cash balances; |
• | Anticipated cash flows from operating activities, including the effects of financing customer term receivables; |
• | Amounts available under existing revolving credit facilities; and |
• | Other available financing sources, such as the issuance of debt or equity securities. |
Our sources of liquidity could be adversely affected by a decrease in demand for our products or a deterioration of our financial ratios.
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OFF-BALANCE SHEET ARRANGEMENTS
We do not have off-balance sheet arrangements, financings, or other similar relationships with unconsolidated entities or other persons, also known as special purpose entities. In the ordinary course of business, we lease certain real properties, primarily field sales offices, research and development facilities, and equipment.
OUTLOOK FOR FISCAL 2009 AND THE FIRST QUARTER OF FISCAL 2010
We expect revenues for the fourth quarter of fiscal 2009 to be approximately $270 million with net income per share of $0.65. We expect revenues for the full fiscal year ending January 31, 2009 to be approximately $815 million with net loss per share of $0.65.
We preliminarily expect revenues for the first quarter of fiscal 2010 to be approximately $200 to $210 million, with net loss per share for the same period in the range of $0.01 to $0.06.
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
(All numerical references in thousands, except for rate data and percentages)
Interest Rate Risk
We are exposed to interest rate risk primarily through our investment portfolio, short-term borrowings, and long-term notes payable. We do not use derivative financial instruments for speculative or trading purposes.
We place our investments in instruments that meet high quality credit standards, as specified in our investment policy. The policy also limits the amount of credit exposure to any one issuer and type of instrument. We do not expect any material loss with respect to our investment portfolio.
The table below presents the carrying amount and related weighted-average fixed interest rates for our investment portfolio. The carrying amount approximates fair value as of October 31, 2008. In accordance with our investment policy, all short-term investments mature in twelve months or less.
Principal (notional) amounts in United States dollars | Carrying Amount | Average Fixed Interest Rate | ||||
Cash equivalents – fixed rate | $ | 45,808 | 1.44 | % | ||
Short-term investments – fixed rate | 1,997 | 2.54 | % | |||
Total fixed rate interest bearing instruments | $ | 47,805 | 1.48 | % | ||
We had convertible subordinated debentures of $165,000 outstanding with a fixed interest rate of 6.25% as of October 31, 2008. For fixed rate debt, interest rate changes affect the fair value of the debentures but do not affect earnings or cash flow.
We had floating rate convertible subordinated debentures of $36,102 outstanding with a variable interest rate of 3-month LIBOR plus 1.65% as of October 31, 2008. For variable interest rate debt, interest rate changes generally do not affect the fair market value, but do affect earnings and cash flow. If the interest rates on the variable rate borrowings were to increase or decrease by 1% for the year and the level of borrowings outstanding remained constant, annual interest expense would increase or decrease by approximately $361.
As of October 31, 2008, we had a syndicated, senior, unsecured, revolving credit facility, which expires on June 1, 2011. Borrowings under the revolving credit facility are permitted to a maximum of $140,000. Under this revolving credit facility, we have the option to pay interest based on: (i) LIBOR with varying maturities which are commensurate with the borrowing period we select, plus a spread of between 1.0% and 1.6%, or (ii) prime plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. As a result, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.25% and 0.35% based on a pricing grid tied to a financial covenant. We paid commitment fees of $89 for the three months ended October 31, 2008 and $259 for the nine months ended October 31, 2008 compared to $77 for the three months ended October 31, 2007 and $228 for the nine months ended October 31, 2007. This revolving credit facility contains certain financial and other covenants, including financial covenants requiring the maintenance of specified liquidity ratios, leverage ratios, and minimum tangible net worth as well as restrictions on the payment of cash dividends. We borrowed $30,000 against the revolving credit facility during the three and nine months ended October 31, 2008. We had no borrowings during the three and nine months ended October 31, 2007. As of October 31, 2008, we had an outstanding balance of $30,000. The interest rate on October 31, 2008 was 4.00%. As of January 31, 2008, we had no outstanding balance against this revolving credit facility.
Including the $30,000 outstanding under the revolving credit facility, we had short-term borrowings of $34,104 outstanding as of October 31, 2008 with variable rates based on market indexes. For variable interest rate debt, interest rate changes generally do not affect the fair market value, but do affect future earnings and cash flow. If the interest rates on the variable rate borrowings were to increase or decrease by 1% for the year and the level of borrowings outstanding remained constant, annual interest expense would increase or decrease by approximately $341.
Foreign Currency Risk
We transact business in various foreign currencies and have established a foreign currency hedging program to hedge certain foreign currency forecasted transactions and exposures from existing assets and liabilities. Our derivative instruments consist
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of short-term foreign currency forward and option contracts. We enter into contracts with counterparties who are major financial institutions and believe the risk related to default is unlikely. We do not hold or issue derivative financial instruments for trading purposes.
We enter into foreign currency option contracts for forecasted revenues and expenses between our foreign subsidiaries. These instruments provide us the right to sell/purchase foreign currencies to/from third parties at future dates with fixed exchange rates. As of October 31, 2008, we had the following options outstanding:
• | Japanese yen with contract values totaling $60,260 at a weighted average contract rate of 113.20 to hedge forecasted revenue exposures; |
• | Euro with contract values totaling $91,551 at a weighted average contract rate of 0.64 to hedge forecasted expense exposures; and |
• | British pound with contract values totaling $32,130 at a weighted average contract rate of 0.48 to hedge forecasted expense exposures. |
We enter into foreign currency forward contracts to protect against currency exchange risk associated with expected future cash flows and existing assets and liabilities. Our practice is to hedge a majority of our existing material foreign currency transaction exposures.
The following table provides information as of October 31, 2008 about our foreign currency forward contracts. The information provided is in United States dollar equivalent amounts. The table presents the notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These contracts mature through the first quarter of the fiscal year ending January 31, 2010.
Notional Amount | Weighted Average Contract Rate | ||||
Forward Contracts: | |||||
Euro | $ | 55,322 | 0.71 | ||
Japanese yen | 45,107 | 102.98 | |||
British pound | 12,549 | 0.55 | |||
Indian rupee | 10,735 | 49.23 | |||
Swedish krona | 8,446 | 7.43 | |||
Taiwan dollar | 7,011 | 32.39 | |||
Swiss franc | 3,405 | 1.14 | |||
Canadian dollar | 3,273 | 1.18 | |||
Danish krone | 2,660 | 5.53 | |||
Polish zloty | 1,727 | 2.65 | |||
Korean won | 1,095 | 1,321.80 | |||
Other | 2,291 | — | |||
Total forward contracts | $ | 153,621 | |||
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Item 4. | Controls and Procedures |
(1) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (Exchange Act), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.
(2) Changes in Internal Controls Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1A. | Risk Factors |
The forward-looking statements contained under “Outlook for Fiscal 2009 and the first quarter of Fiscal 2010” in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and all other statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” “projections,” and words of similar meaning, constitute forward-looking statements that involve a number of risks and uncertainties that are difficult to predict. Moreover, from time to time, we may issue other forward-looking statements. Forward-looking statements regarding financial performance in future periods, including the statements under “Outlook for Fiscal 2009 and the first quarter of Fiscal 2010,” do not reflect potential impacts of mergers or acquisitions or other significant transactions or events that have not been announced as of the time the statements are made. Actual outcomes and results may differ materially from what is expressed or forecast in forward-looking statements. We disclaim any obligation to update forward-looking statements to reflect future events or revised expectations. Our business faces many risks, and set forth below are some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors.
Weakness in the United States (U.S.) and international economies may harm our business.
Our revenue levels are generally dependent on the level of technology capital spending, which includes worldwide expenditures for electronic design automation (EDA) software, hardware, and consulting services. The U.S. and international economies are cyclical and experience periodic economic downturns, which could have a material adverse affect on our results of operations. Weakness in these economies could materially adversely impact the timing and receipt of orders for our products and our results of operations. Weakness could also result in reduced growth, or even negative growth, in the revenue we obtain upon renewals of software term contracts with existing customers.
Our forecasts of our revenues and earnings outlook may be inaccurate.
Our revenues, particularly new software license revenues, are difficult to forecast. We use a “pipeline” system, a common industry practice, to forecast revenues and trends in our business. Sales personnel monitor the status of potential business and estimate when a customer will make a purchase decision, the dollar amount of the sale, and the products or services to be sold. These estimates are aggregated periodically to generate a sales pipeline. Our pipeline estimates may prove to be unreliable either in a particular quarter or over a longer period of time, in part because the “conversion rate” of the pipeline into contracts can be very difficult to estimate and requires management judgment. A variation in the conversion rate could cause us to plan or budget incorrectly and materially adversely impact our business or our planned results of operations. In particular, a slowdown in customer spending or weak economic conditions generally can reduce the conversion rate in a particular quarter as purchasing decisions are delayed, reduced in amount, or cancelled. The conversion rate can also be affected by the tendency of some of our customers to wait until the end of a fiscal quarter attempting to obtain more favorable terms.
Our business could be impacted by fluctuations in quarterly results of operations due to customer seasonal purchasing patterns, the timing of significant orders, and the mix of licenses and products purchased by our customers.
We have experienced, and may continue to experience, varied quarterly operating results. Various factors affect our quarterly operating results and some of these are not within our control, including customer demand and the timing of significant orders. We typically experience seasonality in demand for our products, due to the purchasing cycles of our customers, with revenues in the fourth quarter generally being the highest. In fiscal 2009, we expect revenues to be unusually back-end loaded in the second half of the year, due primarily to planned renewals of existing term contracts with large customers. If these planned contract renewals are delayed or the average size of renewed contracts do not increase as we anticipate, we could fail to meet our and investors’ expectations, which could have a material adverse impact on our stock price.
Our revenues are also affected by the mix of licenses entered into where we recognize software revenues as payments become due and payable, on a cash basis, or ratably over the license term as compared to revenues recognized at the beginning of the license term. We recognize revenues ratably over the license term, for instance, when the customer is provided with rights to unspecified or unreleased future products. A shift in the license mix toward increased ratable, due and payable, and/or cash-based revenue recognition could result in increased deferral of software revenues to future periods and would decrease current revenues, which could result in us not meeting near-term revenue expectations.
The gross margin on our software is greater than that for our hardware emulation systems, software support, and professional services. Therefore, our gross margin may vary as a result of the mix of products and services sold. We also have a
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significant amount of fixed or relatively fixed costs, such as employee costs and purchased technology amortization, and costs which are committed in advance and can only be adjusted periodically. As a result, a small failure to reach planned revenues would likely have a relatively large negative effect on resulting earnings. If anticipated revenues do not materialize as expected, our gross margins and operating results could be materially adversely impacted.
We face intense competition in the EDA industry.
Competition in the EDA industry is intense, which can lead to, among other things, price reductions, longer selling cycles, lower product margins, loss of market share, and additional working capital requirements. If our competitors offer significant discounts on certain products, we may need to lower our prices or offer other favorable terms in order to compete successfully. Any such changes would likely reduce margins and could materially adversely impact our operating results. Any broad-based changes to our prices and pricing policies could cause new software license and service revenues to decline or be delayed as the sales force implements and our customers adjust to the new pricing policies. Some of our competitors may bundle certain software products at low prices for promotional purposes or as a long-term pricing strategy. These practices could significantly reduce demand for our products or constrain prices we can charge.
We currently compete primarily with two large companies: Cadence Design Systems, Inc. (Cadence) and Synopsys, Inc. We also compete with numerous smaller companies and compete with manufacturers of electronic devices that have developed their own EDA products internally.
Our international operations and the effects of foreign currency fluctuations expose us to additional risks.
We generate nearly two-thirds of our revenues from customers outside the U.S. and we generate approximately one-third of our expenses outside the U.S. Significant changes in currency exchange rates could have an adverse impact on us. For further discussion of foreign currency effects, see “Effects of Foreign Currency Fluctuations” discussion in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, international operations subject us to other risks including longer receivables collection periods, changes in a specific country’s or region’s economic or political conditions, trade protection measures, local labor laws, import or export licensing requirements, loss or modification of exemptions for taxes and tariffs, limitations on repatriation of earnings, and difficulties with licensing and protecting our intellectual property rights.
We derive a substantial portion of our revenues from relatively few product groups.
We derive a substantial portion of our revenues from sales of relatively few product groups and related support services. As such, any factor adversely affecting sales of these products, including the product release cycles, market acceptance, product competition, performance and reliability, reputation, price competition, and economic and market conditions, would likely harm our operating results.
Customer payment defaults or related issues could adversely affect our financial condition and results of operations.
We have 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, particularly in the current troubled economic environment. Though we have not, to date, experienced a material level of defaults or renegotiated a material level of pre-existing contractual commitments, any material payment default by our customers or significant reductions in existing contractual commitments could have a material adverse effect on our financial condition and results of operations. These risks may be exacerbated by the current global economic downturn because our revenue forecasts assume (i) customers whose payments are recognized as revenue only when paid will make future payments as scheduled, and (ii) customers whose credit ratings and financial circumstances have deteriorated since we originally booked contracts with them will make future payments as scheduled.
Goodwill and Other Intangible Assets.
We perform an analysis on our goodwill balances to test for impairment on an annual basis or whenever events occur that may indicate impairment possibly exists. Goodwill is deemed to be impaired if the carrying value of a reporting unit exceeds its estimated fair value. Long-lived assets and amortizable intangible assets are tested for impairment when events or circumstances arise indicating that their carrying value may not be recoverable. An impairment charge is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the asset are less than the carrying value of the intangible asset we are testing for impairment. If the forecasted cash flows are less than the carrying value, then we must write down the carrying value to its estimated fair value. As of October 31, 2008, we had a goodwill balance of $440 million and intangible assets of $46 million. Going forward, we will continue to review our goodwill and other intangible
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assets for possible impairment or events or circumstances that would require us to test for impairment. Any impairment charges could adversely affect our future earnings. Goodwill impairment analysis and measurement is a process that requires significant judgment. A decline in our stock price and resulting market capitalization below the carrying value of our reporting unit would result in the need for us to test for impairment if we determine that the decline is sustained. In recent months, our share price and market capitalization has significantly decreased. Conversely, the carrying value of our goodwill has increased with recent acquisitions; if current economic trends continue into the future, it is more likely than in the past that we may need to record an impairment to goodwill. We cannot be certain that a future downturn in our business, changes in market conditions or a longer-term decline in our share price and market capitalization will not result in an impairment of goodwill and the recognition of a material impairment charge in future periods, which could have a material adverse effect on our financial condition and results of operations.
We are subject to the cyclical nature of the integrated circuit (IC) and electronics systems industries.
Purchases of our products and services are highly dependent upon new design projects initiated by customers in the IC and electronics systems industries. These industries are highly cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. The IC and electronics systems industries regularly experience significant downturns, often connected with, or in anticipation of, maturing product cycles within such companies or a decline in general economic conditions. These downturns could cause diminished product demand, production overcapacity, high inventory levels, and accelerated erosion of average selling prices.
Customer payment defaults could harm our business.
We use fixed-term license agreements as a standard business practice with customers we believe are credit-worthy. These multi-year, multi-element term license agreements have payments spread over the license term and are typically about three years in length for semiconductor companies and about four years in length for military and aerospace companies. The complexity of these agreements tends to increase the risk associated with collectibility from customers that can arise for a variety of reasons including ability to pay, product dissatisfaction, disagreements, and disputes. If we are unable to collect under these agreements, our results of operations could be materially adversely impacted. We use these fixed-term license agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. If we no longer had a history of collecting without providing concessions on the terms of the agreements, then revenue would be required to be recognized as the payments become due and payable over the license term. This change could have a material impact on our results.
IC and printed circuit board (PCB) technology evolves rapidly.
The complexity of ICs and PCBs continues to rapidly increase. In response to this increasing complexity, new design tools and methodologies must be invented or acquired quickly to remain competitive. If we fail to quickly respond to new technological developments, our products could become obsolete or uncompetitive, which could materially adversely impact our business.
Errors or defects in our products and services could expose us to liability and harm our reputation.
Our customers use our products and services in designing and developing products that involve a high degree of technological complexity and have unique specifications. Due to the complexity of the systems and products with which we work, some of our products and designs can be adequately tested only when put to full use in the marketplace. As a result, our customers or their end users may discover errors or defects in our software or the systems we design, or the products or systems incorporating our designs and intellectual property may not operate as expected. Errors or defects could result in:
• | Loss of current customers and loss of, or delay in, revenue and loss of market share; |
• | Failure to attract new customers or achieve market acceptance; |
• | Diversion of development resources to resolve the problems resulting from errors or defects; and |
• | Increased support or service costs. |
In addition, we include third party technology in our products and we rely on those third parties to provide support services to us. Failure of those third parties to provide necessary support services could materially adversely impact our business.
Long sales cycles and delay in customer completion of projects make the timing of our revenues difficult to predict.
We have a lengthy sales cycle that generally extends between three and six months. A lengthy customer evaluation and approval process is generally required due to the complexity and expense associated with our products and services.
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Consequently, we may incur substantial expenses and devote significant management effort and expense to develop potential relationships that do not result in agreements or revenues and may prevent us from pursuing other opportunities. In addition, sales of our products and services may be delayed if customers delay approval or commencement of projects due to customers’ budgetary constraints, internal acceptance review procedures, timing of budget cycles, or timing of competitive evaluation processes.
Disruptions of our indirect sales channel could affect our future operating results.
Our indirect sales channel is comprised primarily of independent distributors and sales representatives. Our relationships with these channel participants are important elements of our marketing and sales efforts. Our financial results could be adversely affected if our contracts with channel participants were terminated, if our relationships with channel participants were to deteriorate, if any of our competitors enter into strategic relationships with or acquire a significant channel participant, or if the financial condition of our channel participants were to weaken. In addition, we recently changed from a territory-based sales organization to an account-based organization with an increased emphasis upon our distributors and sales representatives. If this transition takes longer than expected to fully implement, it could adversely affect our financial results in the short-term.
Any loss of our leadership position in certain segments of the EDA market could harm our business.
The industry in which we compete is characterized by very strong leadership positions in specific segments of the EDA market. For example, one company may enjoy a large percentage of sales in the physical verification segment of the market while another will have a similarly strong position in mixed-signal simulation. These strong leadership positions can be maintained for significant periods of time as the software is difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from niche areas in which we are the leader. Conversely, it is difficult for us to achieve significant profits in niche areas where other companies are the leaders. If for any reason we lose our leadership position in a niche, we could be materially adversely impacted.
Accounting rules governing revenue recognition are complex and may change.
The accounting rules governing software revenue recognition are complex and have been subject to authoritative interpretations that have generally made it more difficult to recognize software revenues at the beginning of the license period. If this trend continues, new and revised standards and interpretations could materially adversely impact our ability to meet near-term revenue expectations.
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If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.
Under U.S. generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We could be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could materially adversely impact our results of operations.
We may have additional tax liabilities.
Significant judgments and estimates are required in determining the provision for income taxes and other tax liabilities. Our tax expense may be impacted if our intercompany transactions, which are required to be computed on an arm’s-length basis, are challenged and successfully disputed by the tax authorities. Also, our tax expense could be impacted depending on the applicability of withholding taxes on software licenses and related intercompany transactions in certain jurisdictions. In determining the adequacy of income taxes, we assess the likelihood of adverse outcomes resulting from the Internal Revenue Service (IRS) and other tax authorities’ examinations. The IRS and tax authorities in countries where we do business regularly examine our tax returns. The ultimate outcome of these examinations cannot be predicted with certainty. Should the IRS or other tax authorities assess additional taxes as a result of examinations, we may be required to record charges to operations that could have a material impact on the results of operations, financial position, or cash flows. We were issued a Revenue Agent’s Report in March 2007. See “Provision for Income Taxes” in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional discussion.
Forecasting our income tax rate is complex and subject to uncertainty.
The computation of income tax expense is complex as it is based on the laws of numerous taxing jurisdictions and requires significant judgment on the application of complicated rules governing accounting for tax provision under U.S. generally accepted accounting principles. Income tax expense (benefit) for interim quarters is based on a forecast of our global tax rate for the year, which includes forward looking financial projections, including the expectations of profit and loss by jurisdiction, and contains numerous assumptions. Various items cannot be accurately forecasted, and may be treated as discrete accounting. Examples of items which could cause variability in the rate include tax deductions for stock option expense, application of transfer pricing rules and changes in our valuation allowance for deferred tax assets. Future events, such as changes in our business and the tax law in the jurisdictions where we do business, could also affect our rate. For these reasons, our global tax rate may be materially different than our forecast.
There are limitations on the effectiveness of controls.
We do not expect that disclosure controls or internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Failure of our control systems to prevent error or fraud could materially adversely impact us.
We may not realize revenues as a result of our investments in research and development.
We incur substantial expense to develop new software products. Research and development activities are often performed over long periods of time. This effort may not yield a successful product offering or the product may not satisfy customer requirements. As a result, we could realize little or no revenues related to our investment in research and development.
We may acquire other companies and may not successfully integrate them.
The industry in which we compete has seen significant consolidation in recent years. During this period, we have acquired numerous businesses and have frequently been in discussions with potential acquisition candidates, and we may acquire other businesses in the future. While we expect to carefully analyze all potential transactions before committing to them, we cannot assure that any transaction that is completed will result in long-term benefits to us or our shareholders or that we will be able to manage the acquired businesses effectively. In addition, growth through acquisition involves a number of risks. If any of the following events occurs after we acquire another business, it could materially adversely impact us:
• | Difficulties in combining previously separate businesses into a single unit; |
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• | The substantial diversion of management’s attention from ongoing business when integrating the acquired business; |
• | The discovery after the acquisition has been completed of previously unknown liabilities assumed with the acquired business; |
• | The failure to realize anticipated benefits, such as cost savings and increases in revenues; |
• | The failure to retain key personnel of the acquired business; |
• | Difficulties related to assimilating the products of an acquired business in, for example, distribution, engineering, and customer support areas; |
• | Unanticipated costs; |
• | Unanticipated litigation in connection with or as a result of an acquisition, including claims from terminated employees, customers, or third parties; |
• | Adverse impacts on existing relationships with suppliers and customers; and |
• | Failure to understand and compete effectively in markets in which we have limited experience. |
Acquired businesses may not perform as projected, which could result in impairment of acquisition-related intangible assets. Additional challenges include integration of sales channels, training and education of the sales force for new product offerings, integration of product development efforts, integration of systems of internal controls, and integration of information systems. Accordingly, in any acquisition there will be uncertainty as to the achievement and timing of projected synergies, cost savings, and sales levels for acquired products. All of these factors could impair our ability to forecast, meet revenues and earnings targets, and manage effectively our business for long-term growth. We cannot assure that we can effectively meet these challenges.
Supply problems for our emulation hardware systems could harm our business.
The success of our emulation hardware systems depends on our ability to:
• | Procure hardware components on a timely basis from a limited number of suppliers; |
• | Create stable software for use on the product; |
• | Assemble and ship hardware and software systems on a timely basis with appropriate quality control; |
• | Develop distribution and shipment processes; |
• | Manage inventory and related obsolescence issues; and |
• | Develop processes to deliver customer support for hardware. |
Our inability to be successful in any of the foregoing could materially adversely impact us.
We generally commit to purchase component parts from suppliers based on sales forecasts of our emulation hardware system. If we cannot change or be released from these non-cancelable purchase commitments, and if orders for our products do not materialize, we could incur significant costs related to the purchase of excess components which could become obsolete before we could use them. Additionally, a delay in production of the components or inaccuracy in our sales forecast could materially adversely impact our operating results if we are unable to timely ship ordered products or provide replacement parts under warranty or maintenance contracts.
We may not adequately protect our proprietary rights or we may fail to obtain software or other intellectual property licenses.
Our success depends, in large part, upon our proprietary technology. We generally rely on patents, copyrights, trademarks, trade secret laws, licenses, and restrictive agreements to establish and protect our proprietary rights in technology and products. Despite precautions we may take to protect our intellectual property, we cannot assure that third parties will not try to challenge, invalidate, or circumvent these protections. The companies in the EDA industry, as well as entities and persons outside the industry, are obtaining patents at a rapid rate. Many of these entities have substantially larger patent portfolios than we have. As a result, we may on occasion be forced to engage in costly patent litigation to protect our rights or defend our customers’ rights. We may also need to settle these claims on terms that are unfavorable; such settlements could result in the payment of significant damages or royalties, or force us to stop selling or redesign one or more products. We cannot assure that the rights granted under our patents will provide us with any competitive advantage, that patents will be issued on any of our pending applications, or that future patents will be sufficiently broad to protect our technology. Furthermore, the laws of foreign countries may not protect our proprietary rights in those countries to the same extent as U.S. law protects these rights in the U.S.
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Some of our products include software or other intellectual property licensed from third parties, and we may have to seek new licenses or renew existing licenses for software and other intellectual property in the future. Failure to obtain software or other intellectual property licenses or rights from third parties on favorable terms could materially adversely impact us.
Litigation may materially adversely impact us.
Litigation may result in monetary damages, injunctions against future product sales, and substantial unanticipated legal costs and divert the efforts of management personnel, any and all of which could materially adversely impact us.
Third parties may claim infringement or misuse of intellectual property rights.
We periodically receive notices from others claiming infringement, or other misuse of their intellectual property rights or breach of our agreements with them. We expect the number of such claims will increase as the number of products and competitors in our industry segments grows, the functionality of products overlap, the use and support of third-party code (including open source code) becomes more prevalent in the software industry, and the volume of issued software patents continues to increase. Responding to any such claim, regardless of its validity, could:
• | Be time-consuming, costly and/or result in litigation; |
• | Divert management’s time and attention from developing our business; |
• | Require us to pay monetary damages or enter into royalty and licensing agreements that we would not normally find acceptable; |
• | Require us to stop selling or to redesign certain of our products; |
• | Require us to release source code to third parties, possibly under open source license terms; |
• | Require us to satisfy indemnification obligations to our customers; or |
• | Otherwise adversely affect our business, results of operations, financial condition, or cash flows. |
Our failure to attract and retain key employees may harm us.
We depend on the efforts and abilities of our senior management, our research and development staff, and a number of other key management, sales, support, technical, and services personnel. Competition for experienced, high-quality personnel is intense, and we cannot assure that we can continue to recruit and retain such personnel. Cadence’s public announcement of its unsolicited proposal to acquire all of our outstanding shares during the second quarter of fiscal 2009, even though subsequently withdrawn, created uncertainty for our employees, which may in the short-term adversely affect our ability to retain key employees and hire new employees. Our failure to hire and retain such personnel could impair our ability to develop new products and manage our business effectively.
Terrorist attacks and other acts of violence or war may materially adversely impact the markets on which our securities trade, the markets in which we operate, our operations, and our profitability.
Terrorist attacks may negatively affect our operations and investment in our business. These attacks or armed conflicts may directly impact our physical facilities or those of our suppliers or customers. Furthermore, these attacks may make travel more difficult and expensive and ultimately affect our revenues.
Any armed conflict entered into by the U.S. could have an adverse impact on our revenues and our ability to deliver products to our customers. Political and economic instability in some regions of the world may also result from an armed conflict and could negatively impact our business. We currently have operations in Pakistan, Egypt, India, and Israel, countries that may be particularly susceptible to this risk. The consequences of any armed conflict are unpredictable, and we may not be able to foresee events that could have an adverse impact on us.
More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could result in economic recession in the U.S. or abroad. Any of these occurrences could have a significant impact on our operating results, revenues, and costs and could result in volatility of the market price for our common stock.
Our articles of incorporation, Oregon law, and our shareholder rights plan may have anti-takeover effects.
Our board of directors has the authority, without action by the shareholders, to designate and issue up to 1,200,000 shares of incentive stock in one or more series and to designate the rights, preferences, and privileges of each series without any further vote or action by the shareholders. Additionally, the Oregon Control Share Act and the Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the
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effect of lengthening the time required to acquire control of us through a proxy contest or the election of a majority of the board of directors. Our shareholder rights plan has the effect of making it more difficult for a person to acquire control of us in a transaction not approved by our board of directors. The potential issuance of incentive stock, the provisions of the Oregon Control Share Act and the Business Combination Act, and our shareholder rights plan could have the effect of delaying, deferring, or preventing a change of control of us, could discourage bids for our common stock at a premium over the market price of our common stock and could materially adversely impact the market price of, and the voting and other rights of the holders of, our common stock.
We have a substantial level of indebtedness.
As of October 31, 2008, we had $241 million of outstanding indebtedness, which includes $36 million of Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023, $165 million of 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026, and $40 million in short-term borrowings. This level of indebtedness among other things could:
• | Make it difficult for us to satisfy our payment obligations on our debt; |
• | Make it difficult for us to incur additional indebtedness or obtain any necessary financing in the future for working capital, capital expenditures, debt service, acquisitions, or general corporate purposes; |
• | Limit our flexibility in planning for or reacting to changes in our business; |
• | Reduce funds available for use in our operations; |
• | Make us more vulnerable in the event of a downturn in our business; |
• | Make us more vulnerable in the event of an increase in interest rates if we must incur new debt to satisfy our obligations under the Floating Rate Debentures and 6.25% Debentures; and |
• | Place us at a possible competitive disadvantage relative to less leveraged competitors and competitors that have greater access to capital resources. |
If we experience a decline in revenues, we could have difficulty paying amounts due on our indebtedness. Any default under our indebtedness could have a material adverse impact on our business, operating results, and financial condition.
Our stock price could become more volatile, and your investment could lose value.
All of the factors discussed in this section could affect our stock price. The timing of announcements in the public market regarding new products, product enhancements, or technological advances by our competitors or us, and any announcements by us of acquisitions, major transactions, or management changes could also affect our stock price. Our stock price is subject to speculation in the press and the analyst community, changes in recommendations or earnings estimates by financial analysts, changes in investors’ or analysts’ valuation measures for our stock, our credit ratings, and market trends unrelated to our performance. As a result of Cadence’s unsolicited acquisition proposal during the second quarter of fiscal 2009, and its subsequent withdrawal, the future trading price of our stock in the short-term may be subject to wide price fluctuations. A significant drop in our stock price could also expose us to the risk of securities class actions lawsuits, which could result in substantial costs and divert management’s attention and resources, which could adversely affect our business.
Bank Covenants.
Our bank credit facility imposes operating restrictions on us in the form of financial and non-financial covenants. Financial covenants include Adjusted Quick Ratio, Minimum Tangible Net Worth, Leverage Ratio, Senior Leverage Ratio, and Minimum Cash and Accounts Receivable Ratio. Our bank credit facility provides us with a 30 day cure period in the event of non-compliance of financial covenants. If we were to fail to comply with the financial covenants and did not obtain a waiver from our lenders, we would be in default under the credit facility and our lenders could demand immediate repayment of all outstanding loans under the facility. The declaration of an event of default could have a material adverse effect on our financial condition. We would also likely find it difficult to obtain other bank lines or credit facilities.
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Item 6. | Exhibits |
31.1 | Certification of Chief Executive Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32 | Certifications of Chief Executive Officer and Chief Financial Officer of Registrant Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: December 5, 2008 | MENTOR GRAPHICS CORPORATION (Registrant) | |
/S/ MARIA M. POPE | ||
Maria M. Pope | ||
Vice President and Chief Financial Officer |
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