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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 July 31, 2009
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ 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 September 4, 2009: 98,146,343
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MENTOR GRAPHICS CORPORATION
Page Number | ||||
PART I. FINANCIAL INFORMATION | ||||
Item 1. | Financial Statements (unaudited) | |||
Condensed Consolidated Statements of Operations for the three months ended July 31, 2009 and 2008 | 3 | |||
Condensed Consolidated Statements of Operations for the six months ended July 31, 2009 and 2008 | 4 | |||
Condensed Consolidated Balance Sheets as of July 31, 2009 and January 31, 2009 | 5 | |||
Condensed Consolidated Statements of Cash Flows for the six months ended July 31, 2009 and 2008 | 6 | |||
Notes to Unaudited Condensed Consolidated Financial Statements | 7 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 24 | ||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 39 | ||
Item 4. | Controls and Procedures | 41 | ||
PART II. OTHER INFORMATION | ||||
Item 1A. | Risk Factors | 42 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 50 | ||
Item 6. | Exhibits | 51 | ||
52 |
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PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
Mentor Graphics Corporation
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended July 31, | 2009 | 2008 | ||||||
In thousands, except per share data | As Adjusted (Note 3) | |||||||
Revenues: | ||||||||
System and software | $ | 103,884 | $ | 95,830 | ||||
Service and support | 78,737 | 86,574 | ||||||
Total revenues | 182,621 | 182,404 | ||||||
Cost of revenues: | ||||||||
System and software | 9,511 | 4,356 | ||||||
Service and support | 20,518 | 24,030 | ||||||
Amortization of purchased technology | 2,928 | 1,992 | ||||||
Total cost of revenues | 32,957 | 30,378 | ||||||
Gross margin | 149,664 | 152,026 | ||||||
Operating expenses: | ||||||||
Research and development | 60,843 | 64,251 | ||||||
Marketing and selling | 71,430 | 72,799 | ||||||
General and administration | 21,730 | 24,099 | ||||||
Other general expense (income), net | 68 | (273 | ) | |||||
Amortization of intangible assets | 2,888 | 2,537 | ||||||
Special charges | 4,202 | 3,235 | ||||||
In-process research and development | — | 15,285 | ||||||
Total operating expenses | 161,161 | 181,933 | ||||||
Operating loss | (11,497 | ) | (29,907 | ) | ||||
Other income (expense), net | (356 | ) | 717 | |||||
Interest expense | (4,723 | ) | (4,404 | ) | ||||
Loss before income tax | (16,576 | ) | (33,594 | ) | ||||
Income tax expense (benefit) | 4,690 | (15,796 | ) | |||||
Net loss | $ | (21,266 | ) | $ | (17,798 | ) | ||
Net loss per share: | ||||||||
Basic | $ | (0.22 | ) | $ | (0.19 | ) | ||
Diluted | $ | (0.22 | ) | $ | (0.19 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 94,853 | 91,352 | ||||||
Diluted | 94,853 | 91,352 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Mentor Graphics Corporation
Condensed Consolidated Statements of Operations
(Unaudited)
Six months ended July 31, | 2009 | 2008 | ||||||
In thousands, except per share data | As Adjusted (Note 3) | |||||||
Revenues: | ||||||||
System and software | $ | 219,302 | $ | 192,673 | ||||
Service and support | 157,094 | 168,938 | ||||||
Total revenues | 376,396 | 361,611 | ||||||
Cost of revenues: | ||||||||
System and software | 14,400 | 9,638 | ||||||
Service and support | 41,721 | 49,372 | ||||||
Amortization of purchased technology | 5,876 | 5,230 | ||||||
Total cost of revenues | 61,997 | 64,240 | ||||||
Gross margin | 314,399 | 297,371 | ||||||
Operating expenses: | ||||||||
Research and development | 123,134 | 128,633 | ||||||
Marketing and selling | 148,031 | 149,447 | ||||||
General and administration | 44,766 | 47,160 | ||||||
Other general expense (income), net | 456 | (437 | ) | |||||
Amortization of intangible assets | 5,758 | 4,970 | ||||||
Special charges | 9,897 | 12,885 | ||||||
In-process research and development | — | 15,285 | ||||||
Total operating expenses | 332,042 | 357,943 | ||||||
Operating loss | (17,643 | ) | (60,572 | ) | ||||
Other income (expense), net | (258 | ) | 3,092 | |||||
Interest expense | (8,874 | ) | (9,159 | ) | ||||
Loss before income tax | (26,775 | ) | (66,639 | ) | ||||
Income tax expense (benefit) | 7,447 | (23,345 | ) | |||||
Net loss | $ | (34,222 | ) | $ | (43,294 | ) | ||
Net loss per share: | ||||||||
Basic | $ | (0.36 | ) | $ | (0.48 | ) | ||
Diluted | $ | (0.36 | ) | $ | (0.48 | ) | ||
Weighted average number of shares outstanding: | ||||||||
Basic | 94,514 | 91,054 | ||||||
Diluted | 94,514 | 91,054 | ||||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Mentor Graphics Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
As of | July 31, 2009 | January 31, 2009 | ||||||
In thousands | As Adjusted (Note 3) | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 76,077 | $ | 93,642 | ||||
Short-term investments | 6 | 1,997 | ||||||
Trade accounts receivable, net of allowance for doubtful accounts of $5,504 as of July 31, 2009 and $5,515 as of January 31, 2009 | 259,663 | 272,852 | ||||||
Other receivables | 10,505 | 12,086 | ||||||
Inventory | 4,086 | 11,074 | ||||||
Prepaid expenses and other | 17,314 | 15,986 | ||||||
Deferred income taxes | 8,442 | 10,163 | ||||||
Total current assets | 376,093 | 417,800 | ||||||
Property, plant, and equipment, net of accumulated depreciation of $242,509 as of July 31, 2009 and $228,473 as of January 31, 2009 | 97,063 | 100,991 | ||||||
Term receivables, long-term | 142,132 | 146,682 | ||||||
Goodwill | 446,841 | 441,221 | ||||||
Intangible assets, net of accumulated amortization of $123,801 as of July 31, 2009 and $112,167 as of January 31, 2009 | 29,237 | 39,735 | ||||||
Deferred income taxes | 22,378 | 22,845 | ||||||
Other assets | 15,266 | 16,796 | ||||||
Total assets | $ | 1,129,010 | $ | 1,186,070 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Current liabilities: | ||||||||
Short-term borrowings | $ | 11,269 | $ | 36,998 | ||||
Accounts payable | 9,071 | 10,197 | ||||||
Income taxes payable | 6,082 | 5,340 | ||||||
Accrued payroll and related liabilities | 58,232 | 65,687 | ||||||
Accrued liabilities | 37,786 | 46,034 | ||||||
Deferred revenue | 145,097 | 155,098 | ||||||
Total current liabilities | 267,537 | 319,354 | ||||||
Notes payable | 185,693 | 188,170 | ||||||
Deferred revenue, long-term | 12,730 | 16,890 | ||||||
Income tax liability | 53,980 | 59,078 | ||||||
Other long-term liabilities | 15,050 | 16,133 | ||||||
Total liabilities | 534,990 | 599,625 | ||||||
Commitments and contingencies (Note 9) | ||||||||
Stockholders’ equity: | ||||||||
Common stock, no par value, 200,000 shares authorized; 96,201 shares issued and outstanding as of July 31, 2009 and 94,126 shares issued and outstanding as of January 31, 2009 | 625,417 | 602,064 | ||||||
Accumulated deficit | (61,075 | ) | (26,853 | ) | ||||
Accumulated other comprehensive income | 29,678 | 11,234 | ||||||
Total stockholders’ equity | 594,020 | 586,445 | ||||||
Total liabilities and stockholders’ equity | $ | 1,129,010 | $ | 1,186,070 | ||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Condensed Consolidated Statements of Cash Flows
(Unaudited)
Six months ended July 31, | 2009 | 2008 | ||||||
In thousands | As Adjusted (Note 3) | |||||||
Operating Cash Flows: | ||||||||
Net loss | $ | (34,222 | ) | $ | (43,294 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization of property, plant, and equipment | 16,256 | 15,447 | ||||||
Amortization | 14,518 | 12,729 | ||||||
Write-off of debt issuance costs | 26 | — | ||||||
Impairment of cost-method investments | 113 | — | ||||||
Equity in losses of unconsolidated entities | 568 | 643 | ||||||
Gain on debt extinguishment | (380 | ) | — | |||||
Stock-based compensation | 15,267 | 14,135 | ||||||
Deferred income taxes | 1,634 | (2,229 | ) | |||||
Changes in other long-term liabilities | (2,278 | ) | 304 | |||||
In-process research and development | — | 15,285 | ||||||
Loss on disposal of property, plant, and equipment, net | 190 | 101 | ||||||
Changes in operating assets and liabilities, net of effect of acquired businesses: | ||||||||
Trade accounts receivable, net | 30,516 | 103,956 | ||||||
Prepaid expenses and other | 21,982 | (5,136 | ) | |||||
Term receivables, long-term | 12,037 | 16,079 | ||||||
Accounts payable and accrued liabilities | (27,821 | ) | (35,885 | ) | ||||
Income taxes receivable and payable | (8,122 | ) | (29,586 | ) | ||||
Deferred revenue | (21,071 | ) | (19,412 | ) | ||||
Net cash provided by operating activities | 19,213 | 43,137 | ||||||
Investing Cash Flows: | ||||||||
Proceeds from sales and maturities of short-term investments | 1,990 | 16,236 | ||||||
Purchases of short-term investments | — | (19,310 | ) | |||||
Increase in restricted cash | — | (5,910 | ) | |||||
Purchases of property, plant, and equipment, net | (10,968 | ) | (19,773 | ) | ||||
Acquisitions of businesses and equity interests, net of cash acquired | (7,099 | ) | (48,786 | ) | ||||
Net cash used in investing activities | (16,077 | ) | (77,543 | ) | ||||
Financing Cash Flows: | ||||||||
Proceeds from issuance of common stock | 8,890 | 14,362 | ||||||
Tax benefit from share options exercised | — | 25 | ||||||
Net decrease in short-term borrowings | (5,394 | ) | (7,472 | ) | ||||
Debt issuance costs | (149 | ) | — | |||||
Repayments of notes payable and revolving credit facility | (23,450 | ) | — | |||||
Net cash provided by (used in) financing activities | (20,103 | ) | 6,915 | |||||
Effect of exchange rate changes on cash and cash equivalents | (598 | ) | 238 | |||||
Net change in cash and cash equivalents | (17,565 | ) | (27,253 | ) | ||||
Cash and cash equivalents at the beginning of the period | 93,642 | 117,926 | ||||||
Cash and cash equivalents at the end of the period | $ | 76,077 | $ | 90,673 | ||||
See accompanying notes to unaudited condensed consolidated financial statements.
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Mentor Graphics Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
All numerical references are 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, 2009. |
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, liabilities, and contingencies as of the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. As future events and their effects cannot be determined with precision, actual results could differ from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
(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 9. “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 hardware system 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 $3,617 for the three months ended July 31, 2009 and $7,639 for the six months ended July 31, 2009 compared to $4,257 for the three months ended July 31, 2008 and $8,928 for the six months ended July 31, 2008.
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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.
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. With respect to emulation hardware systems, we transfer title to the customer upon shipment. We offer non-essential installation services for emulation hardware system sales or the customer may elect to perform the installation without assistance from us. Our software license and 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.
Significant judgment is involved in assessing whether a fee is fixed or determinable. We must also make these judgments when assessing whether a contract amendment to a term arrangement (primarily in the context of a license extension or renewal) constitutes a concession. Our experience has been that we are able to determine whether a fee is fixed or determinable for term licenses. While we do not expect that experience to change, if we no longer were to have a history of collecting under the original contract without providing concessions on term licenses, revenue from term licenses would be required to be recognized when payments under the installment contract become due and payable. Such a change could have a material impact on our results of operations.
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.
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Other General Expense (Income), Net
The gain or loss on the sale of qualifying receivables to certain financing institutions on a non-recourse basis is recorded in Other general expense (income), net, a component of Operating expenses. The gain or loss 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.
(3) | Change in Accounting—During the first quarter of fiscal 2010, we adopted the provisions of Financial Accounting Standards Board Staff Position (FSP) Accounting Principles Board (APB) 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (FSP APB 14-1). FSP APB 14-1 requires that issuers of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) separately account for the implied liability and equity components of the convertible debt in a manner that reflects the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 applies to the 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026. Prior to the adoption of FSP APB 14-1, we carried the liability of the 6.25% Debentures at its principal value and only the contractual interest expense was recognized in our Condensed Consolidated Statements of Operations. FSP APB 14-1 requires retrospective application to all prior periods for which the 6.25% Debentures were outstanding prior to the date of adoption. |
Upon adoption of FSP APB 14-1 and effective as of the issuance date of the 6.25% Debentures, we recorded $23,976 of the principal amount to equity, representing a debt discount for the difference between our estimated nonconvertible debt borrowing rate of 8.60% at the time of issuance and the coupon rate of the 6.25% Debentures. This debt discount is amortized as interest expense over the expected term using the effective interest method. In addition, we allocated $764 of the issuance costs to the equity component of the 6.25% Debentures and the remaining $5,606 of the issuance costs to the liability component of the 6.25% Debentures. The issuance costs were allocated pro rata based on their initial carrying amounts.
The impact of FSP APB 14-1 to Interest expense, Loss before income tax, Net loss, and Basic and diluted net loss per share for the three and six months ended July 31, 2008 represents the amortization of the debt discount and adjustment of the previously recorded amortization of the issuance costs. The adjustments to the Condensed Consolidated Balance Sheet as of January 31, 2009 reflect adjustments of:
• | Other assets and Prepaid expenses and other for the impact of the allocation of a portion of the issuance costs to equity; |
• | Notes payable for the unamortized debt discount on the 6.25% Debentures; |
• | Common stock for the recognition of the equity component of the 6.25% Debentures, net of a portion of the equity component that was retired upon repurchase of a portion of the 6.25% Debentures; and |
• | Accumulated deficit for the cumulative debt discount amortization, revised issuance cost amortization, and revised loss on the retirement of a portion of the debt recognized in interest expense from the issuance date of the 6.25% Debentures through January 31, 2009. |
The impact of the adoption of FSP APB 14-1 on the Condensed Consolidated Statements of Operations for the three and six months ended July 31, 2008 is as follows:
Three months ended July 31, 2008 | Six months ended July 31, 2008 | |||||||||||||||||||||||
As Originally Reported | Impact of Accounting Change for FSP APB 14-1 | As Amended | As Originally Reported | Impact of Accounting Change for FSP APB 14-1 | As Amended | |||||||||||||||||||
Operating loss | $ | (29,907 | ) | $ | — | $ | (29,907 | ) | $ | (60,572 | ) | $ | — | $ | (60,572 | ) | ||||||||
Other income, net | 717 | — | 717 | 3,092 | — | 3,092 | ||||||||||||||||||
Interest expense | (3,798 | ) | (606 | ) | (4,404 | ) | (7,960 | ) | (1,199 | ) | (9,159 | ) | ||||||||||||
Loss before income tax | (32,988 | ) | (606 | ) | (33,594 | ) | (65,440 | ) | (1,199 | ) | (66,639 | ) | ||||||||||||
Income tax benefit | (15,796 | ) | — | (15,796 | ) | (23,345 | ) | — | (23,345 | ) | ||||||||||||||
Net loss | $ | (17,192 | ) | $ | (606 | ) | $ | (17,798 | ) | $ | (42,095 | ) | $ | (1,199 | ) | $ | (43,294 | ) | ||||||
Basic and diluted net loss per share | $ | (0.19 | ) | $ | — | $ | (0.19 | ) | $ | (0.46 | ) | $ | (0.02 | ) | $ | (0.48 | ) | |||||||
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The impact of the adoption of FSP APB 14-1 on the Condensed Consolidated Balance Sheet as of January 31, 2009 is as follows:
As of January 31, 2009 | ||||||||||||
As Previously Reported | Impact of Accounting Change for FSP APB 14-1 | As Adjusted | ||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 93,642 | $ | — | $ | 93,642 | ||||||
Short-term investments | 1,997 | — | 1,997 | |||||||||
Trade accounts receivable, net | 272,852 | — | 272,852 | |||||||||
Other receivables | 12,086 | — | 12,086 | |||||||||
Inventory | 11,074 | — | 11,074 | |||||||||
Prepaid expenses and other | 16,076 | (90 | ) | 15,986 | ||||||||
Deferred income taxes | 10,163 | — | 10,163 | |||||||||
Total current assets | 417,890 | (90 | ) | 417,800 | ||||||||
Property, plant, and equipment, net | 100,991 | — | 100,991 | |||||||||
Term receivables, long-term | 146,682 | — | 146,682 | |||||||||
Goodwill | 441,221 | — | 441,221 | |||||||||
Intangible assets, net | 39,735 | — | 39,735 | |||||||||
Deferred income taxes | 22,845 | — | 22,845 | |||||||||
Other assets | 17,073 | (277 | ) | 16,796 | ||||||||
Total assets | $ | 1,186,437 | $ | (367 | ) | $ | 1,186,070 | |||||
Liabilities and Stockholder’s Equity | ||||||||||||
Total current liabilities | $ | 319,354 | $ | — | $ | 319,354 | ||||||
Notes payable | 201,102 | (12,932 | ) | 188,170 | ||||||||
Deferred revenue, long-term | 16,890 | — | 16,890 | |||||||||
Income tax liability | 59,078 | — | 59,078 | |||||||||
Other long-term liabilities | 16,133 | — | 16,133 | |||||||||
Total liabilities | 612,557 | (12,932 | ) | 599,625 | ||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 580,298 | 21,766 | 602,064 | |||||||||
Accumulated deficit | (17,652 | ) | (9,201 | ) | (26,853 | ) | ||||||
Accumulated other comprehensive income | 11,234 | — | 11,234 | |||||||||
Total stockholders’ equity | 573,880 | 12,565 | 586,445 | |||||||||
Total liabilities and stockholders’ equity | $ | 1,186,437 | $ | (367 | ) | $ | 1,186,070 | |||||
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The impact of the adoption of FSP APB 14-1 on the Condensed Consolidated Statement of Cash Flows for the six months ended July 31, 2008 is as follows:
Six months ended July 31, 2008 | ||||||||||||||||
As Originally Reported | Impact of Accounting Change for | |||||||||||||||
FSP APB 14-1 | Other | As Amended | ||||||||||||||
Operating Cash Flows: | ||||||||||||||||
Net loss | $ | (42,095 | ) | $ | (1,199 | ) | $ | — | $ | (43,294 | ) | |||||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization of property, plant, and equipment | 15,447 | — | — | 15,447 | ||||||||||||
Amortization | 11,530 | 1,199 | — | 12,729 | ||||||||||||
Equity in losses of unconsolidated entities | 643 | — | — | 643 | ||||||||||||
Stock-based compensation | 14,135 | — | — | 14,135 | ||||||||||||
Deferred income taxes | (2,229 | ) | — | — | (2,229 | ) | ||||||||||
Changes in other long-term liabilities | 374 | — | (70 | ) | 304 | |||||||||||
In-process research and development | 15,285 | — | — | 15,285 | ||||||||||||
Loss on disposal of property, plant, and equipment, net | 101 | — | — | 101 | ||||||||||||
Changes in operating assets and liabilities, net of effect of acquired businesses: | ||||||||||||||||
Trade accounts receivable, net | 103,956 | — | — | 103,956 | ||||||||||||
Prepaid expenses and other | (5,136 | ) | — | — | (5,136 | ) | ||||||||||
Term receivables, long-term | 16,079 | — | — | 16,079 | ||||||||||||
Accounts payable and accrued liabilities | (35,955 | ) | — | 70 | (35,885 | ) | ||||||||||
Income taxes receivable and payable | (29,586 | ) | — | — | (29,586 | ) | ||||||||||
Deferred revenue | (19,412 | ) | — | — | (19,412 | ) | ||||||||||
Net cash provided by operating activities | 43,137 | — | — | 43,137 | ||||||||||||
Investing Cash Flows: | ||||||||||||||||
Net cash used in investing activities | (77,543 | ) | — | — | (77,543 | ) | ||||||||||
Financing Cash Flows: | ||||||||||||||||
Net cash provided by financing activities | 6,915 | — | — | 6,915 | ||||||||||||
Effect of exchange rate changes on cash and cash equivalents | 238 | — | — | 238 | ||||||||||||
Net change in cash and cash equivalents | (27,253 | ) | — | — | (27,253 | ) | ||||||||||
Cash and cash equivalents at the beginning of the period | 117,926 | — | — | 117,926 | ||||||||||||
Cash and cash equivalents at the end of the period | $ | 90,673 | $ | — | $ | — | $ | 90,673 | ||||||||
(4) | Fair Value Measurement—On a quarterly basis, we measure derivative instruments at fair value. Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (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 required to be carried at fair value on a recurring basis as of July 31, 2009:
Fair Value as of July 31, 2009 | Level 1 | Level 2 | Level 3 | |||||||||
Foreign currency exchange contracts | $ | 3,422 | $ | — | $ | 3,422 | $ | — |
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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 contracts 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 6. “Derivative Instruments and Hedging Activities.”
The carrying amounts of Cash equivalents, Short-term investments, Trade accounts receivable, net, Term receivables, Short-term borrowings, Accounts payable, and Accrued liabilities approximate fair value because of the short-term nature of these instruments or because amounts have been appropriately discounted. We record foreign currency exchange contracts based on quoted market prices. The fair value of Notes payable was $176,795 as of July 31, 2009 and $134,549 as of January 31, 2009 compared to the carrying value of $185,693 as of July 31, 2009 and $188,170 as of January 31, 2009. We based the fair value of Notes payable on the quoted market price or rates available to us for instruments with similar terms and maturities.
(5) | Business Combinations—During the three and six months ended July 31, 2009, we acquired two privately held companies, which were not material individually or in the aggregate. Both of these acquisitions included an upfront payment that was treated as consideration for the business combination. In addition, each acquisition calls for potential future payments, which were not considered contingent consideration and will be expensed as incurred if and when specific milestones are achieved. |
The separate results of operations for the acquisitions during the three and six months ended July 31, 2009 were not material, individually or in the aggregate, compared to our overall results of operations and accordingly proforma financial statements of the combined entities have been omitted.
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 January 31, 2009, we had acquired all of the outstanding or to be outstanding, ordinary shares of Flomerics. We have integrated Flomerics into our Mechanical Analysis Division.
The total purchase price for Flomerics, including acquisition and exit costs, was $58,588. The excess of tangible assets acquired over liabilities assumed was $13,549, including cash of $12,411. The purchase accounting allocations resulted in goodwill of $19,660, 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.
During the three months ended July 31, 2008, we also acquired a privately held company, which was not material. This acquisition included an upfront payment that was treated as consideration for the business combination.
The separate results of operations for the acquisitions during the three and six months ended July 31, 2008 were not material, individually or in the aggregate, compared to our overall results of operations and accordingly proforma financial statements of the combined entities have been omitted.
(6) | 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. |
To partially offset the net exposures in the euro, British pound, and the Japanese yen, we enter into foreign currency exchange contracts of a year or less which are designated as cash flow hedges. Any gain or loss on Japanese yen contracts is classified as product revenue when the hedged transaction occurs while any gain or loss on euro and British pound contracts is classified as operating expense when the hedged transaction occurs. During the six months ended July 31, 2009, we entered into fifteen new foreign currency option contracts, with a total gross notional value of $81,492 and eighty-three new foreign currency forward contracts, with a total gross notional value of $359,046.
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We formally document all relationships between foreign currency exchange 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 exchange 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 exchange 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 exchange contract is not highly effective as a hedge under the requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (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 (expense), net in the Condensed Consolidated Statement of Operations. We noted no such instance during the six months ended July 31, 2009 or 2008.
Effective February 1, 2009, we adopted the disclosure requirement of SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment to Statement No. 133” (SFAS 161). In accordance with SFAS 161, the fair values and balance sheet presentation of our derivative instruments as of July 31, 2009 are summarized as follows:
As of July 31, 2009 | |||||||||
Location | Asset Derivatives | Liability Derivatives | |||||||
Derivatives designated as SFAS 133 hedging instruments | |||||||||
Cash flow forwards | Other receivables | $ | 2,341 | $ | — | ||||
Derivatives not designated as SFAS 133 hedging instruments | |||||||||
Non-designated forwards | Other receivables | 1,607 | (526 | ) | |||||
Total derivatives | $ | 3,948 | $ | (526 | ) | ||||
We had foreign currency exchange contracts outstanding with a gross notional value of $324,907 as of July 31, 2009. Notional amounts do not quantify risk or represent our assets or liabilities but are used in the calculation of cash settlements under the contracts.
By using derivative instruments, we subject ourselves to credit risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, our credit risk will equal the fair value of the derivative instrument. Generally when the fair value of our derivative contracts is in a net asset position, the counterparty owes us, thus creating a receivable risk for us. We minimize counterparty credit risk by entering into derivative transactions with major financial institutions and, as such, we do not expect material losses as a result of default by our counterparties.
In accordance with SFAS 161, the pre-tax effect of derivative instruments in cash flow hedging relationships on income and other comprehensive income (OCI) for the six months ended July 31, 2009 is as follows:
Derivatives Designated as SFAS | Gain (Loss) Recognized in OCI on Derivatives (Effective Portion) | Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing) | ||||||||||||
Amount | Location | Amount | Location | Amount | |||||||||||
Cash flow forwards | $ | 5,674 | Revenues | $ | (1,597 | ) | Other income (expense), net | $ | 144 | ||||||
Operating expenses | (400 | ) | |||||||||||||
Cash flow options | 13 | Revenues | (164 | ) | Other income (expense), net | (5 | ) | ||||||||
Operating expenses | (561 | ) | |||||||||||||
Total | $ | 5,687 | $ | (2,722 | ) | $ | 139 | ||||||||
Included in the gain on cash flow forwards of $144 recognized in Other income (expense), net was a gain of $141 related to the time value exclusion of foreign currency forward contracts from our assessment of hedge effectiveness.
The hedge balance in Accumulated other comprehensive income as of July 31, 2009 of $1,410, after tax effect, represents a net unrealized gain on foreign currency exchange contracts related to hedges of forecasted revenues and
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expenses expected to occur within the next twelve months. We will transfer these amounts to the Condensed Consolidated Statement of Operations upon recognition of the related revenues and recording of the respective expenses. We expect substantially all of the hedge balance in Accumulated other comprehensive income to be reclassified to the Condensed Consolidated Statement of Operations within the next twelve months.
We enter into foreign currency exchange 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. The effect of derivative instruments not designated as hedging instruments on income for the six months ended July 31, 2009 is as follows:
Derivatives Not Designated as SFAS 133 Hedging Instruments | Gain (Loss) Recognized in Income on Derivatives | ||||
Location | Amount | ||||
Non-designated forwards | Other income (expense), net | $ | 6,154 |
(7) | 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. In March 2009, we amended the revolving credit facility to reduce the minimum tangible net worth calculated as of January 31, 2009, which is used as the starting point for future calculations, by $15,000, and to make certain other changes reflected in the discussion below. Under this revolving credit facility, we have the option to pay interest based on: (i) London Interbank Offered Rate (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) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. 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 $107 for the three months ended July 31, 2009 and $184 for the six months ended July 31, 2009 compared to $83 for the three months ended July 31, 2008 and $158 for the six months ended July 31, 2008. This revolving credit facility contains certain financial and other covenants, including the following: |
• | Our adjusted quick ratio (ratio of the sum of cash and cash equivalents, short-term investments, and net current receivables to total current liabilities) shall not be less than 0.85; |
• | Our tangible net worth (stockholders’ equity less goodwill and other intangible assets) must exceed the calculated required tangible net worth as defined in the credit agreement, which establishes a fixed level of required tangible net worth. Each quarter the required level increases by 70% of any positive net income in the quarter (but in the aggregate no more than 70% of positive net income for any full fiscal year), 100% of the amortization of intangible assets in the quarter, and 100% of certain stock issuance proceeds. The required level also decreases each quarter by certain amounts of acquired intangible assets; |
• | Our leverage ratio (ratio of total liabilities less subordinated debt to the sum of subordinated debt and tangible net worth) shall not be greater than 2.20; |
• | Our senior leverage ratio (ratio of total debt less subordinated debt to the sum of subordinated debt and tangible net worth) shall be less than 0.90; and |
• | Our minimum cash and accounts receivable ratio (ratio of the sum of cash and cash equivalents, short-term investments, and 47.5% of net current accounts receivable, to outstanding credit agreement borrowings) shall not be less than 1.25. |
The revolving credit facility prevents us from paying dividends.
We were in compliance with all financial covenants as of July 31, 2009. 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 revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility.
During the six months ended July 31, 2009, we did not borrow any amount under the revolving credit facility and we repaid $20,000. We had no borrowings during the six months ended July 31, 2008. As of July 31, 2009, we had no balance outstanding against this revolving credit facility, as compared to an outstanding balance of $20,000 as of January 31, 2009. The interest rate was 3.85% as of July 31, 2009 and 3.25% as of January 31, 2009.
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Short-term borrowings of $7,085 as of July 31, 2009 and $12,550 as of January 31, 2009 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 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 $4,184 as of July 31, 2009 and $4,448 as of January 31, 2009.
(8) | Notes Payable—Notes payable consisted of the following: |
As of | ||||||
July 31, 2009 | January 31, 2009 | |||||
6.25% Debentures due 2026 | $ | 153,421 | $ | 152,068 | ||
Floating Rate Debentures due 2023 | 32,272 | 36,102 | ||||
Notes payable | $ | 185,693 | $ | 188,170 | ||
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 July 31, 2009. 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 six months ended July 31, 2009, we did not repurchase any 6.25% Debentures and the principal amount of $165,000 remains outstanding.
During the first quarter of fiscal 2010, we adopted FSP APB 14-1, which specifies that issuers of convertible debt that may be settled in cash upon conversion (including partial cash settlement) separately account for the implied liability and equity components of the convertible debt in a manner that reflects the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 applies to our 6.25% Debentures. FSP APB 14-1 requires retrospective application to all periods. The impact of the adoption of FSP APB 14-1 is further described in Note 3. “Change in Accounting.”
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The principal amount, unamortized debt discount and net carrying amount of the liability component as well as the carrying amount of the equity component of the 6.25% Debentures are as follows:
As of | ||||||||
July 31, 2009 | January 31, 2009 | |||||||
Principal amount | $ | 165,000 | $ | 165,000 | ||||
Unamortized debt discount | (11,579 | ) | (12,932 | ) | ||||
Net carrying amount of the liability component | $ | 153,421 | $ | 152,068 | ||||
Equity component | $ | 21,766 | $ | 21,766 | ||||
The remaining unamortized debt discount will be amortized to interest expense using the effective interest method through March 2013.
We recognized the following amounts in interest expense in the Condensed Consolidated Statement of Operations related to the 6.25% Debentures:
Three months ended July 31, | Six months ended July 31, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Interest expense at the contractual interest rate | $ | 2,578 | $ | 2,578 | $ | 5,156 | $ | 5,156 | ||||
Amortization of debt discount | 684 | 628 | 1,353 | 1,243 |
The effective interest rate on the 6.25% Debentures was 8.60% for both the six months ended July 31, 2009 and 2008.
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 2.82% for the six months ended July 31, 2009 and 4.67% for the six months ended July 31, 2008. 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 1,379 shares as of July 31, 2009. 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 six months ended July 31, 2009, we purchased on the open market and retired Floating Rate Debentures with a principal balance of $3,830 for a total purchase price of $3,450. As a result, a principal amount of $32,272 remains outstanding as of July 31, 2009. In connection with this purchase, during the six months ended July 31, 2009, we incurred a before tax net gain on the early extinguishment of debt of $354, which included a $380 discount on the repurchased Floating Rate Debentures and a write-off of $26 of a portion of unamortized deferred debt issuance costs.
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(9) | 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, 2009.
Income Taxes
As of July 31, 2009, we had a liability of $53,980 for income taxes associated with uncertain income tax positions. All of these tax positions 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.
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 July 31, 2009, 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.
(10) | 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.
The 1987 Non-Employee Directors’ Stock Plan 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. There were 7 restricted shares with a fair market value of $36 issued under this plan during the three and six months ended July 31, 2009 and 14 restricted shares with a fair market value of $214 issued under this plan during the three and six months ended July 31, 2008. Options granted under this plan are included in the table below.
As of July 31, 2009, a total of 6,604 shares of common stock were available for future grant under the above stock option and stock plans.
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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, 2009 | 20,597 | $ | 13.19 | |||
Granted | 222 | $ | 5.22 | |||
Exercised | (5 | ) | $ | 5.51 | ||
Forfeited | (99 | ) | $ | 9.85 | ||
Expired | (1,365 | ) | $ | 13.06 | ||
Balance as of July 31, 2009 | 19,350 | $ | 13.13 | |||
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 six thousand 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 July 31, 2009, 9,516 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. In reaching our determination of expected volatility for options, we include the following elements:
• | Historical volatility of our shares of common stock; |
• | Historical volatility of shares of comparable companies; and |
• | Implied volatility of traded options of comparable companies. |
In reaching our determination of expected volatility for purchase rights under our employee stock plan, we use the historical volatility of our shares of common stock.
We base the expected term of our stock options on historical experience. Using the Black-Scholes option-pricing model, the weighted average grant date fair values are summarized as follows:
Three months ended July 31, | Six months ended July 31, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Options Granted | $ | 5.36 | $ | 6.91 | $ | 5.22 | $ | 5.67 | ||||
Restricted Stock Granted | $ | 5.14 | $ | 15.29 | $ | 5.14 | $ | 15.29 | ||||
ESPP Purchase Rights | $ | 2.88 | $ | 4.63 | $ | 2.92 | $ | 4.55 |
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The calculations used the following assumptions:
Three months ended July 31, | Six months ended July 31, | |||||||||||
Stock Option Plans | 2009 | 2008 | 2009 | 2008 | ||||||||
Risk-free interest rate | 2.9 | % | 3.4 | % | 2.7 | % | 3.1 | % | ||||
Dividend yield | 0 | % | 0 | % | 0 | % | 0 | % | ||||
Expected life (in years) | 5.0 - 6.5 | 5.0 - 6.5 | 5.0 - 6.5 | 5.0 - 6.5 | ||||||||
Volatility (range) | 45 - 50 | % | 45 - 50 | % | 45 - 50 | % | 45 - 50 | % | ||||
Volatility (weighted average) | 48 | % | 47 | % | 47 | % | 46 | % | ||||
Three months ended July 31, | Six months ended July 31, | |||||||||||
Employee Stock Purchase Plans | 2009 | 2008 | 2009 | 2008 | ||||||||
Risk-free interest rate | 0.7 | % | 4.6 | % | 1.1 | % | 4.7 | % | ||||
Dividend yield | 0 | % | 0 | % | 0 | % | 0 | % | ||||
Expected life (in years) | 1.25 | 1.25 | 1.25 | 1.25 | ||||||||
Volatility (range) | 46% - 49 | % | 34% - 45 | % | 44% - 49 | % | 33% - 45 | % | ||||
Volatility (weighted average) | 47 | % | 43 | % | 47 | % | 43 | % |
(11) | 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 and 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 July 31, | Six months ended July 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net loss | $ | (21,266 | ) | $ | (17,798 | ) | $ | (34,222 | ) | $ | (43,294 | ) | ||||
Weighted average common shares used to calculate basic and diluted net loss per share | 94,853 | 91,352 | 94,514 | 91,054 | ||||||||||||
Basic net loss per share | $ | (0.22 | ) | $ | (0.19 | ) | $ | (0.36 | ) | $ | (0.48 | ) | ||||
Diluted net loss per share | $ | (0.22 | ) | $ | (0.19 | ) | $ | (0.36 | ) | $ | (0.48 | ) | ||||
We excluded from the computation of diluted net loss per share options, warrants, and ESPP purchase rights to purchase 22,055 shares of common stock for the three and six months ended July 31, 2009 compared to 18,482 for the three and six months ended July 31, 2008. The options, warrants, and ESPP purchase rights 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).
The effect of the conversion of the Floating Rate Debentures and the 6.25% Debentures was anti-dilutive and therefore excluded from the computation of diluted net loss per share. If the Floating Rate Debentures had been dilutive, our diluted net loss would have included additional earnings of $170 for the three months ended July 31, 2009 and $371 for the six months ended July 31, 2009 compared to $283 for the three months ended July 31, 2008 and $585 for the six months ended July 31, 2008 and additional incremental common shares of 1,391 for the three months ended July 31, 2009 and 1,452 for the six months ended July 31, 2009 compared to 1,543 for the three and six months ended July 31, 2008. 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 $2,108 for the three months ended July 31, 2009 and $4,206 for the six months ended July 31, 2009 compared to $2,073 for the three months ended July 31, 2008 and $4,154 for the six months ended July 31, 2008 and additional incremental shares of 9,182 for the three and six months ended July 31, 2008 and 2009. 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 8. “Notes Payable.”
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(12) | Comprehensive Income (Loss)—The following provides a summary of comprehensive income (loss): |
Six months ended July 31, | ||||||||
2009 | 2008 | |||||||
Net loss | $ | (34,222 | ) | $ | (43,294 | ) | ||
Change in unrealized loss on derivative instruments | 7,920 | 1,966 | ||||||
Change in accumulated translation adjustment | 10,557 | 2,322 | ||||||
Change in pension liability under SFAS 158 | (33 | ) | — | |||||
Comprehensive loss | $ | (15,778 | ) | $ | (39,006 | ) | ||
(13) | Special Charges—The following is a summary of the components of the special charges: |
Three months ended July 31, | Six months ended July 31, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Employee severance and related costs | $ | 1,599 | $ | 730 | $ | 5,627 | $ | 8,844 | ||||
Excess leased facility costs | 865 | 1,513 | 824 | 2,956 | ||||||||
Acquisition costs | 270 | — | 538 | — | ||||||||
Other costs | 1,468 | 992 | 2,908 | 1,085 | ||||||||
Total special charges | $ | 4,202 | $ | 3,235 | $ | 9,897 | $ | 12,885 | ||||
Special 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.
Employee severance costs of $5,627 during the six months ended July 31, 2009 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts 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 63% of these costs were paid during the six months ended July 31, 2009. We expect to pay the remainder during the second half of fiscal 2010. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $824 during the six months ended July 31, 2009 were primarily due to the abandonment of leased facilities and changes in the estimate of sublease income for previously abandoned leased facilities.
Acquisition costs of $538 during the six months ended July 31, 2009 represent legal and other costs related to acquisitions and potential future acquisitions.
Other special charges for the six months ended July 31, 2009 included costs of $2,350 related to advisory fees, charges of $507 related to a casualty loss, and other charges of $51.
Employee severance costs of $8,844 during the six months ended July 31, 2009 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts 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, 2009. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $2,956 during the six months ended July 31, 2008 were primarily due to the abandonment of leased facilities and a change in the estimate of sublease income of a previously abandoned leased facility.
Other special charges for the six months ended July 31, 2008 included costs of $93 related to the closure of a division, costs of $1,073 related to advisory fees, and other charges of $(81).
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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 six months ended July 31, 2009:
Accrued special charges as of January 31, 2009 | Charges during the six months ended July 31, 2009 | Payments during the six months ended July 31, 2009 | Accrued special charges as of July 31, 2009 (1) | ||||||||||
Employee severence and related costs | $ | 3,183 | $ | 5,627 | $ | (5,310 | ) | $ | 3,500 | ||||
Excess leased facility costs | 4,456 | 824 | (428 | ) | 4,852 | ||||||||
Acquisition costs | — | 538 | (414 | ) | 124 | ||||||||
Other costs | 692 | 2,908 | (2,308 | ) | 1,292 | ||||||||
�� | |||||||||||||
Total accrued special charges | $ | 8,331 | $ | 9,897 | $ | (8,460 | ) | $ | 9,768 | ||||
(1) | Of the $9,768 total accrued special charges as of July 31, 2009, $2,732 represented the long-term portion of accrued lease termination fees and other facility costs, net of sublease income. The remaining balance of $7,036 represented the short-term portion of accrued special charges. |
(14) | In-Process Research and Development—We incurred $13,985 of in-process research and development charges during the three months ended July 31, 2008 related to undeveloped technology acquired through a joint development agreement with IBM addressing technological challenges of integrated circuit design at 22 nanometer 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 our Calibre® product family once development is completed. |
Other in-process research and development charges for the three and six months ended July 31, 2008 relate to acquisitions of businesses. See further discussion of these amounts in Note 5. “Business Combinations.”
(15) | Other Income (Expense), Net—Other income (expense), net was comprised of the following: |
Three months ended July 31, | Six months ended July 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Interest income | $ | 251 | $ | 1,351 | $ | 655 | $ | 2,914 | ||||||||
Foreign currency exchange gain (loss) | (129 | ) | (73 | ) | (208 | ) | 1,111 | |||||||||
Other, net | (478 | ) | (561 | ) | (705 | ) | (933 | ) | ||||||||
Other income (expense), net | $ | (356 | ) | $ | 717 | $ | (258 | ) | $ | 3,092 | ||||||
(16) | 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 $9,216 for the three months ended July 31, 2009 and $17,445 for the six months ended July 31, 2009. These amounts represented 5.0% of our total revenues for the three months ended July 31, 2009 and 4.6% for the six months ended July 31, 2009. We recognized revenue from these customers of $18,048 for the three months ended July 31, 2008 and $26,631 for the six months ended July 31, 2008. These amounts represented 9.9% of our total revenues for the three months ended July 31, 2008 and 7.4% for the six months ended July 31, 2008. Management believes the transactions between these customers and us were carried out on an arm’s-length basis. |
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(17) | Supplemental Cash Flow Information—The following provides information concerning supplemental disclosures of cash flow activities: |
Six months ended July 31, | ||||||
2009 | 2008 | |||||
Cash paid, net for: | ||||||
Interest | $ | 7,471 | $ | 7,503 | ||
Income taxes | $ | 7,513 | $ | 1,938 |
(18) | 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 and the President. |
We operate exclusively in the electronic design automation (EDA) 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. The corporate component of Operating 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:
Three months ended July 31, | Six months ended July 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: | ||||||||||||||||
North America | $ | 88,475 | $ | 64,734 | $ | 162,939 | $ | 136,115 | ||||||||
Europe | 53,153 | 58,382 | 95,663 | 111,564 | ||||||||||||
Japan | 15,293 | 33,893 | 49,933 | 68,434 | ||||||||||||
Pacific Rim | 25,700 | 25,395 | 67,861 | 45,498 | ||||||||||||
Total revenues | $ | 182,621 | $ | 182,404 | $ | 376,396 | $ | 361,611 | ||||||||
Operating income (loss): | ||||||||||||||||
North America | $ | 49,591 | $ | 32,195 | $ | 90,513 | $ | 67,088 | ||||||||
Europe | 31,804 | 31,661 | 52,670 | 54,099 | ||||||||||||
Japan | 6,437 | 23,832 | 30,340 | 48,234 | ||||||||||||
Pacific Rim | 16,314 | 18,596 | 49,928 | 32,017 | ||||||||||||
Corporate | (115,643 | ) | (136,191 | ) | (241,094 | ) | (262,010 | ) | ||||||||
Total operating loss | $ | (11,497 | ) | $ | (29,907 | ) | $ | (17,643 | ) | $ | (60,572 | ) | ||||
Income (loss) before income tax: | ||||||||||||||||
North America | $ | 45,272 | $ | 28,138 | $ | 82,181 | $ | 59,961 | ||||||||
Europe | 31,075 | 32,148 | 51,879 | 54,995 | ||||||||||||
Japan | 6,423 | 23,815 | 30,314 | 48,220 | ||||||||||||
Pacific Rim | 16,297 | 18,496 | 49,945 | 32,195 | ||||||||||||
Corporate | (115,643 | ) | (136,191 | ) | (241,094 | ) | (262,010 | ) | ||||||||
Total loss before income tax | $ | (16,576 | ) | $ | (33,594 | ) | $ | (26,775 | ) | $ | (66,639 | ) | ||||
For the three months ended July 31, 2009, one customer accounted for 15% of our total revenues. For the six months ended July 31, 2009, one customer accounted for 11% of our total revenues. No single customer accounted for 10% or more of total revenues for the three or six months ended July 31, 2008.
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As of | ||||||
July 31, 2009 | January 31, 2009 | |||||
Property, plant, and equipment, net: | ||||||
North America | $ | 72,575 | $ | 72,419 | ||
Europe | 18,369 | 20,913 | ||||
Japan | 1,509 | 2,278 | ||||
Pacific Rim | 4,610 | 5,381 | ||||
Total property, plant, and equipment | $ | 97,063 | $ | 100,991 | ||
Goodwill: | ||||||
North America | $ | 407,942 | $ | 403,502 | ||
Europe | 34,718 | 33,492 | ||||
Japan | 1,367 | 1,454 | ||||
Pacific Rim | 2,814 | 2,773 | ||||
Total goodwill | $ | 446,841 | $ | 441,221 | ||
Total assets: | ||||||
North America | $ | 725,180 | $ | 741,244 | ||
Europe | 290,828 | 328,153 | ||||
Japan | 84,180 | 77,286 | ||||
Pacific Rim | 28,822 | 39,387 | ||||
Total assets | $ | 1,129,010 | $ | 1,186,070 | ||
We segregate revenue into five categories of similar products and services. Each category includes both product and related support revenues. Revenue information is as follows:
Three months ended July 31, | Six months ended July 31, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Revenues: | ||||||||||||
IC Design to Silicon | $ | 64,399 | $ | 53,745 | $ | 148,891 | $ | 119,488 | ||||
Functional Verification | 48,715 | 44,819 | 89,105 | 86,744 | ||||||||
Integrated System Design | 41,908 | 42,818 | 79,440 | 78,058 | ||||||||
New & Emerging Products | 15,522 | 24,331 | 35,306 | 44,690 | ||||||||
Services & Other | 12,077 | 16,691 | 23,654 | 32,631 | ||||||||
Total revenues | $ | 182,621 | $ | 182,404 | $ | 376,396 | $ | 361,611 | ||||
(19) | Subsequent Events—Effective for the period ended July 31, 2009, we adopted the provisions of SFAS No. 165 “Subsequent Events” and have evaluated subsequent events from August 1, 2009 to our filing date of September 4, 2009. |
On August 18, 2009, we acquired all of the outstanding common shares of LogicVision, Inc. (LogicVision), a test and yield learning company in the semiconductor design-for-test sector. Under the terms of the purchase agreement, LogicVision shareholders received 0.2006 of a share of our common stock for each LogicVision common share. As a result of this agreement, we issued 1,903 shares of our common stock to the former common shareholders of LogicVision. Thus, the value of the aggregate consideration given for our acquisition of LogicVision was approximately $14,000, at our closing price on August 18, 2009 of $7.51 per share. The transaction was structured as a stock-for-stock reverse triangular merger whereby a wholly owned subsidiary of ours merged with and into LogicVision, with LogicVision surviving the merger as a wholly owned subsidiary of ours. The acquisition was an investment aimed at extending our product offerings within the EDA industry. The allocation of the purchase price among intangible assets, in-process research and development, and tax deductibility of goodwill has not been determined due to the timing of the acquisition date. The separate results of operations for this acquisition were not material compared to our overall results of operations and accordingly pro-forma financial statements of the combined entities have been omitted.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
All numerical references included in tables are in thousands, except for percentages.
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.
We focus on products and design platforms where we have leading market share, thus enabling us to spend more effort to cause adoption of our technology in new applications, especially for new markets in which EDA companies have not participated. We believe this strategy leads to a more diversified product and customer mix than many of our competitors and can help reduce volatility of business, credit risk, and competition, while increasing the potential for growth. System customers make up a much larger percentage of our business than that of most of our EDA competitors.
We derive system and software revenues primarily from the sale of term software license contracts, which are typically three to four years in length. We generally recognize revenue for these arrangements upon product delivery at the beginning of the license term. Larger enterprise-wide customer contracts, which in the aggregate can represent as much as 50% of our system and software revenue, drive the majority of our period-to-period revenue variances. We categorize term licenses where collectibility is not probable and revenue is recognized on a cash basis as ratable license revenues. Additionally, ratable license revenues also include short-term term licenses as well as other term licenses where we provide the customer with rights to unspecified or unreleased future products. For these reasons, the timing, size, customer circumstances, and license terms are the primary drivers of revenue changes from period to period, with new contracts and increases in the capacity of existing contracts driving revenue changes to a lesser extent.
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 software product. For these reasons, 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 projects initiated by customers in the integrated circuit and electronics system industries. These industries can be 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. Furthermore, extended economic downturns can result in reduced funding for development due to downsizing and other business restructurings. These pressures are offset by the need for the development and introduction of next generation products once an economic recovery occurs.
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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.
Known Trends and Uncertainties Impacting Future Results of Operations
In the United States (U.S.) and abroad, market and economic conditions have been unprecedented in the recent past and challenging, with tighter credit conditions, increased market volatility, diminished expectations for the U.S. and global economies, and increased market uncertainty and stability in both U.S. and international capital and credit markets. These conditions, combined with generally 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. Many lenders and institutional investors reduced, and in some cases, ceased to provide funding to borrowers due to the absence of a securitization market and concerns about the stability of the markets generally and the strength of the counterparties specifically. 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 refinance maturing liabilities, resulting in an adverse effect on our financial condition and results of operations.
The semiconductor industry experienced a bounce back from the major reductions in supply chain inventories in the fourth quarter of fiscal 2009 and first half of fiscal 2010, with foundries reporting a recovery in loadings, leading many semiconductor companies to increase earnings guidance. However, bankruptcies and credit problems continue and had an effect on our revenues during the first half of fiscal 2010.
The semiconductor industry is particularly vulnerable in this economy as several of the largest companies lack the balance sheet strength that they historically carried into recessions. Consistent with our revenue recognition policy, when individual customer credit worthiness declines to a level where we do not consider collectibility probable, we convert new transactions from up-front revenue recognition to cash-based revenue recognition and we may be required to modify the payment terms to meet the customer’s ability to pay. Our top ten accounts make up approximately 40% of our receivables, including both short and long term balances, and we have not experienced and do not presently expect collection issues with these customers. Net of reserves, we have no receivables greater than 60 days past due, and continue to experience no difficulty in factoring our receivables.
Bad debt expense recorded for the first half of fiscal 2010 was not material. However, we do have exposures within our receivables portfolio to some of the larger semiconductor companies with weak credit ratings. These receivables balances do not represent a material portion of our portfolio but could have a material effect on earnings in any given quarter, should additional allowances for doubtful accounts be necessary.
We rely on smaller dollar contracts for a material portion of our business. During fiscal 2009, we experienced a decline in these transactions, which we believe contributed to a decline in our revenue for fiscal 2009. For the first half of fiscal 2010, we continued to see a lower contribution from these accounts and the timing of recovery is unknown.
We noted a decline in service and support revenues in the first half of fiscal 2010. A multi-quarter increase or decrease in service and support revenue can be an early indicator that our business is either strengthening or weakening. In the second quarter of fiscal 2010, we saw a leveling off in the rate of declined software maintenance renewals. In addition, we saw a decline in consulting and training revenues in the first half of fiscal 2010. Our experience is that customers will scale back on the purchase of outsourcing services in times of economic decline or weakness.
Bookings during the first six months of fiscal 2010 improved by approximately 20% compared to the first six months of fiscal 2009. 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 six months ended July 31, 2009 accounted for approximately 55% of total system and software bookings compared to approximately 40% for the six months ended July 31, 2008. The number of new customers during the six months ended July 31, 2009, excluding PADS (our ready to use printed circuit board design tools) and our Flomerics Group, PLC (Flomerics) mechanical analysis tools, decreased approximately 50% from the levels experienced during the six months ended July 31, 2008.
Product Developments
During the six months ended July 31, 2009, 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.
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We believe that the development and commercialization of EDA software tools is generally a three to five year process with limited customer adoption and sales in the first years of tool availability. Once tools are adopted, however, their life spans tend to be long. We introduced new products and upgrades to existing products in the first half of fiscal 2010 that we believe have the potential for widespread customer adoption and may have a favorable impact on future periods. During the six months ended July 31, 2009, we did not have any significant products reaching the end of their useful economic life.
Critical Accounting Policies
We base our discussion and analysis of our financial condition and results of operations upon our condensed consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions 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, current facts, 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 and the recording of revenue, costs, and expenses that are not readily apparent from other sources. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.
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 condensed 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, 2009.
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RESULTS OF OPERATIONS
Revenues and Gross Margins
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||||||
System and software revenues | $ | 103,884 | 8 | % | $ | 95,830 | $ | 219,302 | 14 | % | $ | 192,673 | ||||||||||
System and software gross margin | $ | 91,445 | 2 | % | $ | 89,482 | $ | 199,026 | 12 | % | $ | 177,805 | ||||||||||
Gross margin percent | 88 | % | 93 | % | 91 | % | 92 | % | ||||||||||||||
Service and support revenues | $ | 78,737 | (9 | %) | $ | 86,574 | $ | 157,094 | (7 | %) | $ | 168,938 | ||||||||||
Service and support gross margin | $ | 58,219 | (7 | %) | $ | 62,544 | $ | 115,373 | (4 | %) | $ | 119,566 | ||||||||||
Gross margin percent | 74 | % | 72 | % | 73 | % | 71 | % | ||||||||||||||
Total revenues | $ | 182,621 | 0 | % | $ | 182,404 | $ | 376,396 | 4 | % | $ | 361,611 | ||||||||||
Total gross margin | $ | 149,664 | (2 | %) | $ | 152,026 | $ | 314,399 | 6 | % | $ | 297,371 | ||||||||||
Gross margin percent | 82 | % | 83 | % | 84 | % | 82 | % |
System and Software
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||
Upfront license revenues | $ | 86,502 | 14 | % | $ | 75,991 | $ | 184,051 | 22 | % | $ | 151,191 | ||||||
Ratable license revenues | 17,382 | (12 | %) | 19,839 | 35,251 | (15 | %) | 41,482 | ||||||||||
Total system and software revenues | $ | 103,884 | 8 | % | $ | 95,830 | $ | 219,302 | 14 | % | $ | 192,673 | ||||||
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. Upfront license revenues are comprised of perpetual licenses and term licenses for which we recognize revenue upon product delivery at the start of the license term. We categorize term licenses where collectibility is not probable and revenue is recognized on a cash basis as ratable license revenues. Additionally, ratable license revenues also include short-term term licenses, term licenses where we provide the customer with rights to unspecified or unreleased future products, and finance fee revenues from the accretion on the discount of long-term installment receivables.
Our top ten customers accounted for approximately 60% of total System and software revenues for the three and six months ended July 31, 2009 compared to approximately 50% for the three months ended July 31, 2008 and approximately 45% for the six months ended July 31, 2008. For the three months ended July 31, 2009, one customer accounted for 15% of our total revenues for the period. For the six months ended July 31, 2009, one customer accounted for 11% of our total revenues for the period. For the three and six months ended July 31, 2008, no single customer accounted for 10% or more of total revenues. Sales of product associated with our acquisition of Flomerics in the second quarter of fiscal 2009 resulted in increases in System and software revenues of $4.2 million during the three months ended July 31, 2009 and $8.4 million during the six months ended July 31, 2009.
Foreign currency had an overall negative impact on our revenues of $1.2 million during the three months ended July 31, 2009 compared to the three months ended July 31, 2008, primarily as a result of a weakening of the euro and British pound against the U.S. dollar, partially offset by the strengthening of the Japanese yen against the U.S. dollar. Foreign currency had an overall negative impact on our revenues of $3.4 million during the six months ended July 31, 2009 compared to the six months ended July 31, 2008, primarily as a result of a weakening of the euro and British pound against the U.S. dollar, partially offset by the strengthening of the Japanese yen against the U.S. dollar.
System and software gross margin percent decreased for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 primarily due to increased emulation hardware system revenues. Our emulation systems typically have lower margins than our classic software product revenues due to substantial hardware content.
Amortization of purchased technology to System and software cost of revenues was $2.9 million for the three months ended July 31, 2009 and $5.9 million for the six months ended July 31, 2009 compared to $2.0 million for the three months ended July 31, 2008 and $5.2 million for the six months ended July 31, 2008. We amortize purchased technology costs over two to five years. The increase in amortization for the three and six months ended July 31, 2009 was primarily due to the Flomerics acquisition.
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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. Professional services are a lower margin offering which is staffed according to fluctuations in demand while support services operate under a less variable cost structure resulting in improved margins as revenue increases. Excluding the effect of the Flomerics acquisition, 66% of the reduction in Service and support revenues was due to lower support services for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 and 59% for the six months ended July 31, 2009 compared to the six months ended July 31, 2008. The decrease in revenues was primarily the result of the softening of the global economy as our customers scaled back on annual maintenance renewals and purchases of outsourced services. These decreases were offset by increased Service and support revenues resulting from our acquisition of Flomerics of $2.7 million for the three months ended July 31, 2009 and $5.5 million for the six months ended July 31, 2009.
Service and support gross margin percent increased for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 primarily due to cost reductions of $2.2 million, including reductions in outside service costs, headcount-related costs and travel costs. These improvements to costs were partially offset by the impact of lower revenues of $7.8 million.
Service and support gross margin percent increased for the six months ended July 31, 2009 compared to the three months ended July 31, 2008 primarily due to cost reductions of $6.7 million, including reductions in outside service costs, headcount-related costs, travel costs, and favorable foreign currency movements. These improvements to costs were partially offset by the impact of lower revenues of $11.8 million.
Geographic Revenues Information
Revenue by Geography
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||
North America | $ | 88,475 | 37 | % | $ | 64,734 | $ | 162,939 | 20 | % | $ | 136,115 | ||||||
Europe | 53,153 | (9 | %) | 58,382 | 95,663 | (14 | %) | 111,564 | ||||||||||
Japan | 15,293 | (55 | %) | 33,893 | 49,933 | (27 | %) | 68,434 | ||||||||||
Pacific Rim | 25,700 | 1 | % | 25,395 | 67,861 | 49 | % | 45,498 | ||||||||||
Total revenue | $ | 182,621 | 0 | % | $ | 182,404 | $ | 376,396 | 4 | % | $ | 361,611 | ||||||
For the six months ended July 31, 2009, approximately one-third of European and almost all Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. For the six months ended July 31, 2008, approximately one-fourth of European and ninety percent of Japanese revenues were subject to exchange rate fluctuations. We recognize additional revenues in periods when the U.S. dollar weakens in value against these foreign currencies. Likewise, we recognize lower revenues in periods when the U.S. dollar strengthens in value against these foreign currencies. The effects of exchange rate differences from foreign currencies to the U.S. dollar unfavorably impacted revenues by 1% for the three and six months ended July 31, 2009.
For additional description of how changes in foreign exchange rates affect our Condensed Consolidated Financial Statements, see discussion under the heading, “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Disclosure About Market Risk – Foreign Currency Risk.”
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Operating Expenses
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||||
Research and development | $ | 60,843 | (5 | %) | $ | 64,251 | $ | 123,134 | (4 | %) | $ | 128,633 | ||||||||
Marketing and selling | 71,430 | (2 | %) | 72,799 | 148,031 | (1 | %) | 149,447 | ||||||||||||
General and administration | 21,730 | (10 | %) | 24,099 | 44,766 | (5 | %) | 47,160 | ||||||||||||
Other general expense (income), net | 68 | 125 | % | (273 | ) | 456 | 204 | % | (437 | ) | ||||||||||
Amortization of intangible assets | 2,888 | 14 | % | 2,537 | 5,758 | 16 | % | 4,970 | ||||||||||||
Special charges | 4,202 | 30 | % | 3,235 | 9,897 | (23 | %) | 12,885 | ||||||||||||
In-process research and development | — | (100 | %) | 15,285 | — | (100 | %) | 15,285 | ||||||||||||
Total operating expenses | $ | 161,161 | (11 | %) | $ | 181,933 | $ | 332,042 | (7 | %) | $ | 357,943 | ||||||||
Research and Development
Research and development expenses decreased by $3.4 million for the three months ended July 31, 2009 compared to the three months ended July 31, 2008, and by $5.5 million for the six months ended July 31, 2009 compared to the six months ended July 31, 2008. The components of these decreases are summarized as follows:
Change | ||||||||
Three months ended July 31, | Six months ended July 31, | |||||||
Salaries, variable compensation, and benefits expenses | $ | (2.4 | ) | $ | (5.3 | ) | ||
Facilities and infrastructure related costs | (0.4 | ) | (1.1 | ) | ||||
Travel costs | (0.5 | ) | (1.3 | ) | ||||
Stock based compensation | 0.1 | 0.7 | ||||||
Increased expenses due to business combinations | 0.8 | 2.3 | ||||||
Other expenses | (1.0 | ) | (0.8 | ) | ||||
Total change in research and development expenses | $ | (3.4 | ) | $ | (5.5 | ) | ||
Marketing and Selling
Marketing and selling expenses decreased by $1.4 million for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 and by $1.4 million for the six months ended July 31, 2009 compared to the six months ended July 31, 2008. The components of these decreases are summarized as follows:
Change | ||||||||
Three months ended July 31, | Six months ended July 31, | |||||||
Salaries, variable compensation, and benefits expenses | $ | (0.8 | ) | $ | (2.8 | ) | ||
Facilities and infrastructure related costs | (0.7 | ) | 0.3 | |||||
Travel costs | (1.8 | ) | (3.6 | ) | ||||
Stock based compensation | 0.3 | 0.7 | ||||||
Increased expenses due to business combinations | 2.5 | 5.7 | ||||||
Other expenses | (0.9 | ) | (1.7 | ) | ||||
Total change in marketing and selling expenses | $ | (1.4 | ) | $ | (1.4 | ) | ||
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General and Administration
General and administrative expenses decreased by $2.4 million for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 and by $2.4 million for the six months ended July 31, 2009 compared to the six months ended July 31, 2008. The components of these decreases are summarized as follows:
Change | ||||||||
Three months ended July 31, | Six months ended July 31, | |||||||
Salaries, variable compensation, and benefits expenses | $ | (0.4 | ) | $ | (0.7 | ) | ||
Facilities and infrastructure related costs | (0.3 | ) | (0.5 | ) | ||||
Travel costs | (0.2 | ) | (0.5 | ) | ||||
Stock based compensation | (0.6 | ) | (0.4 | ) | ||||
Other expenses | (0.9 | ) | (0.3 | ) | ||||
Total change in general and administration expenses | $ | (2.4 | ) | $ | (2.4 | ) | ||
We incur a substantial portion of our operating expenses outside the U.S. in various foreign currencies. When these currencies weaken against the U.S. dollar, our operating expense performance improves and when these currencies strengthen, our operating expense performance is adversely affected. For the three months ended July 31, 2009 compared to the three months ended July 31, 2008, we experienced favorable currency movements of $8.5 million in total operating expenses. For the six months ended July 31, 2009 compared to the six months ended July 31, 2008, we experienced favorable currency movements of $17.4 million in total operating expenses. The impact of these favorable currency movements is reflected in the movements in operating expenses detailed above.
Other General Expense (Income), Net
Other general expense (income), net represents the expense (loss) or income (gain) on the sale of qualifying receivables to certain financing institutions on a non-recourse basis. The increase in expense from the three and six months ended July 31, 2008 to the three and six months ended July 31, 2009 was primarily due to higher interest rates charged against factored receivables and a decrease in the amount of receivables sold.
Amortization of Intangible Assets
For the three and six months ended July 31, 2009 compared to the three and six months ended July 31, 2008, the increase in amortization of intangible assets was primarily due to an increase in amortization of certain intangible assets acquired in the Flomerics acquisition of approximately $0.5 million for the three months ended July 31, 2009 and approximately $0.9 million for the six months ended July 31, 2009.
Special Charges
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||
Employee severance and related costs | $ | 1,599 | 119 | % | $ | 730 | $ | 5,627 | (36 | %) | $ | 8,844 | ||||||
Excess leased facility costs | 865 | (43 | %) | 1,513 | 824 | (72 | %) | 2,956 | ||||||||||
Acquisition costs | 270 | 100 | % | — | 538 | 100 | % | — | ||||||||||
Other costs | 1,468 | 48 | % | 992 | 2,908 | 168 | % | 1,085 | ||||||||||
Total special charges | $ | 4,202 | 30 | % | $ | 3,235 | $ | 9,897 | (23 | %) | $ | 12,885 | ||||||
Special 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. Special charges may also include expenses incurred related to potential acquisitions, excess facility costs, and asset-related charges.
Employee severance costs of $1.6 million during the three months ended July 31, 2009 and $5.6 million during the six months ended July 31, 2009 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which was individually material to our financial position or results of operations. We determined termination benefit amounts 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 63% of the year to date costs were paid during the six months ended July 31, 2009. We expect to pay the remainder during the second half of fiscal 2010. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $0.8 million during the six months ended July 31, 2009 were primarily due to the abandonment of leased facilities and changes in the estimates of sublease income for previously abandoned leased facilities.
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Acquisition costs of $0.3 million during the three months ended July 31, 2009 and $0.5 million during the six months ended July 31, 2009 represent legal and other costs related to acquisitions and potential future acquisitions.
Other special charges for the three months ended July 31, 2009 included costs of $1.2 million related to advisory fees and $0.3 million in other charges. Other special charges for the six months ended July 31, 2009 included costs of $2.4 million related to advisory fees and charges and $0.6 million in other charges.
Employee severance costs of $0.7 million during the three months ended July 31, 2008 and $8.8 million during the six months ended July 31, 2008 included severance benefits, notice pay, and outplacement services. The total rebalance charge represents the aggregate of numerous unrelated rebalance plans which impacted several employee groups, none of which were individually material to our financial position or results of operations. We determined termination benefit amounts 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, 2009. There have been no significant modifications to the amount of these charges.
Excess leased facility costs of $1.5 million during the three months ended July 31, 2008 and $3.0 million during the six months ended July 31, 2008 were primarily due to the abandonment of leased facilities and a change in the estimate of sublease income of a previously abandoned leased facility.
Other special charges for the six months ended July 31, 2008 included costs of $1.1 million related to advisory fees.
Targeted Reductions for Fiscal 2010
For fiscal 2010, as part of our planning process we targeted $35.0 million of reductions (inclusive of beneficial foreign currency movements) to our prior year base operating expenses in Research and development, Marketing and selling, and General and administration. We identified and put in action a series of programs to reduce costs. Travel has been sharply restricted. We have frozen wages, curtailed hiring, and selectively reduced employee compensation and benefits. We reduced headcount in the first half of fiscal 2010.
Overall operating expenses (before Special charges and In-process research and development) were down approximately 4% for the three months ended July 31, 2009 and approximately 2% for the six months ended July 31, 2009 as a result of our cost reduction programs and favorable currency movements of approximately $8.5 million for the three months ended July 31, 2009 and $17.4 million for the six months ended July 31, 2009. These benefits were net of costs associated with the operations of Flomerics and prior year annual salary increases, which were not in effect in the first half of fiscal 2009. We expect cost saving trends to be more apparent in the second half of fiscal 2010 as costs associated with Flomerics’ operations and salary increases become comparative on a quarterly basis.
We have operations in foreign jurisdictions where the U.S. dollar has strengthened relative to the prior year. Our planned cost savings assume continued strength of the U.S. dollar relative to those currencies in most foreign jurisdictions compared to fiscal 2009 levels.
During the three months ended July 31, 2009, we began to recognize savings from actions taken in the first half of fiscal 2010 associated with employee rebalances included in Special charges. We expect to recognize more meaningful benefits from actions taken in the first half of fiscal 2010 in the remainder of fiscal 2010 in the form of employee expense reductions.
Our targeted cost reductions for fiscal 2010 did not contemplate an increase in costs resulting from completed and potential acquisitions which we may or may not successfully complete in fiscal 2010 and, accordingly, the operating costs of the acquired businesses in fiscal 2010 are expected to reduce our targeted cost savings.
In-process Research and Development
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||
In-process research and development | $ | — | (100 | %) | $ | 15,285 | $ | — | (100 | %) | $ | 15,285 |
Prior to adopting Statement of Financial Accounting Standards (SFAS) No. 141(R) “Business Combinations” (SFAS 141(R)) on February 1, 2009, in-process research and development was expensed upon acquisition in Operating expenses in our Condensed Consolidated Statement of Operations. Effective upon the adoption SFAS 141(R), in-process research and development is capitalized to Intangible assets as part of the purchase price allocation. Upon completion of the project, the in-process research and development will be amortized over the life of the product to Cost of revenues. Alternatively, if the project is determined to be unlikely to achieve completion, the in-process research and development costs will be expensed as Operating expense.
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In-process research and development of $15.3 million for the three and six months ended July 31, 2008 included $1.3 million for the Ponte acquisition and $14.0 million resulting from undeveloped technology acquired through a joint development agreement with IBM addressing technological challenges of integrated circuit design at 22 nanometer (nm) geometries.
The $1.3 million for the Ponte acquisition was assigned to one project, Litho-Etch. We based the value of the Ponte 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 for the product was the fourth quarter of fiscal 2009. The project was still in development as of July 31, 2009 with a new expected commercialization date in the fourth quarter of fiscal 2010. 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 the Ponte 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.
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 our Calibre® product family once development is completed. The product release date has yet to be determined.
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.
Other Income (Expense), Net
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||||||
Interest income | $ | 251 | (81 | %) | $ | 1,351 | $ | 655 | (78 | %) | $ | 2,914 | ||||||||||
Foreign currency exchange gain (loss) | (129 | ) | (77 | %) | (73 | ) | (208 | ) | (119 | %) | 1,111 | |||||||||||
Other, net | (478 | ) | 15 | % | (561 | ) | (705 | ) | 24 | % | (933 | ) | ||||||||||
Other income (expense), net | $ | (356 | ) | (150 | %) | $ | 717 | $ | (258 | ) | (108 | %) | $ | 3,092 | ||||||||
The decline in interest income for the three and six months ended July 31, 2009 compared to the three and six months ended July 31, 2008 was primarily due to the decrease of interest earned on our cash, cash equivalents, and short-term investments resulting from a decline in our cash held in interest bearing accounts and a decline in the interest rates received on interest bearing accounts.
The decrease in foreign currency exchange gain (loss) for the six months ended July 31, 2009 compared to the six months ended July 31, 2008 was primarily due to unfavorable movements of exchange rates on certain balance sheet positions in Europe during the six months ended July 31, 2009.
Interest Expense
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||
Interest expense | $ | 4,723 | 7 | % | $ | 4,404 | $ | 8,874 | (3 | %) | $ | 9,159 |
The increase in interest expense for the three months ended July 31, 2009 compared to the three months ended July 31, 2008 was primarily due to the increase in interest expense for the time value of foreign currency contracts of approximately $0.3 million for the three months ended July 31, 2009.
Provision for Income Taxes
Three months ended July 31, | Six months ended July 31, | |||||||||||||||||||
2009 | Change | 2008 | 2009 | Change | 2008 | |||||||||||||||
Income tax expense (benefit) | $ | 4,690 | (130 | %) | $ | (15,796 | ) | $ | 7,447 | (132 | %) | $ | (23,345 | ) |
Generally, the provision for income taxes is the result of the mix of profit and loss 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
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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.
We expect to incur tax expense for the year ending January 31, 2010, even though we project a loss on our income statement for the full fiscal year. This is primarily because we expect to record a net profit from international operations, thereby incurring expense while we anticipate losses in the U.S. Any tax benefit in the U.S. will generally be offset by an increase in the valuation allowance on U.S. deferred tax assets. This inability to utilize the benefit of our U.S. losses is the primary reason for our expected negative tax rate for fiscal 2010. For the six months ended July 31, 2009, our effective tax rate was (28%) after considering discrete items totaling $3.5 million of tax benefit. Our effective tax rate for the six months ended July 31, 2009 without discrete items was (41%). For fiscal 2010, we project a (34%) effective tax rate, with the inclusion of discrete items. This differs from tax computed at the U.S. federal statutory rate primarily due to:
• | Projected U.S. losses for which no tax benefit will be recognized; and |
• | Withholding taxes in certain foreign jurisdictions. |
These differences are partially 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 2010 could change significantly if actual results differ from our 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 calculated the deferred tax assets and liabilities using the enacted tax rates and laws that will be in effect when we expect the 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. Consistent with prior years, we recorded valuation allowances in fiscal 2009 and expect to continue to record valuation allowances in fiscal 2010 against the portion of those net deferred tax assets for which realization is uncertain. Valuation allowances relating to non-U.S. taxing jurisdictions were based on 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 and, in the ordinary course of business, 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, and 2004 tax years. In March 2007, the IRS issued a Revenue Agent’s Report for 2002 through 2004 in which adjustments were asserted totaling $146.6 million of additional taxable income. The adjustments primarily concern transfer-pricing arrangements related to intellectual property rights acquired in acquisitions that were transferred to a foreign subsidiary. Although we continue to contest 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.
We have reserves for taxes 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 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. For the six months ended July 31, 2009, we reflected a $5.1 million reduction in reserves for
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potential tax liabilities, principally due to the expiration of the statute of limitations in certain jurisdictions, with $2.6 million of that reduction included as a discrete item of tax benefit in the six months ended July 31, 2009. We expect to record additional reserves in future periods with respect to tax positions taken for the current year. It is reasonably possible that unrecognized tax positions may decrease from $0 to $20.0 million due to settlements or expirations of the statute of limitations within the next twelve months. To the extent that uncertain tax positions resolve in our favor, it could have a positive impact on our effective tax rate. A significant portion of reserves, which could settle or expire within the next twelve months, may result in the booking of deferred tax assets subject to a valuation allowance for which no benefit would be recognized.
LIQUIDITY AND CAPITAL RESOURCES
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 our revolving credit facility.
As of July 31, 2009, we had cash and cash equivalents of $76.1 million. 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. To date, we have experienced no loss or lack of access to our invested cash; 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 may 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 are subject to other adverse conditions in the financial markets.
We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis:
• | Current cash balances; |
• | Anticipated cash flows from operating activities, including the effects of selling and 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, although the capital markets have been volatile and we cannot assure you that we will be able to raise debt or equity capital on acceptable terms. |
Six months ended July 31, | 2009 | 2008 | ||||||
Cash provided by operating activities | $ | 19,213 | $ | 43,137 | ||||
Cash used in investing activities | $ | (16,077 | ) | $ | (77,543 | ) | ||
Cash provided by (used in) financing activities | $ | (20,103 | ) | $ | 6,915 |
Operating Activities
Cash flows from operating activities consist of our net loss, adjusted for certain non-cash items and changes in operating assets and liabilities. Our cash flows from operating activities are significantly influenced by the payment terms on our license agreements and by our sales of qualifying accounts receivable. As a result of the current global economic downturn, our customers may not be able to make future payments as scheduled or may seek to renegotiate pre-existing contractual commitments due to adverse changes in their own businesses. Our customers’ inability to fulfill payment obligations could adversely affect our cash flow. Though we have not, to date, experienced a material level of defaults, material payment defaults by our customers as a result of the current economic conditions or otherwise could have a material adverse effect on our financial condition. To address these concerns, we are monitoring our accounts receivable portfolio for customers with low or declining credit ratings and have increased our collection efforts over the last year.
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Trade Accounts and Term Receivables
As of | July 31, 2009 | January 31, 2009 | ||||
Trade accounts receivable, net | $ | 259,663 | $ | 272,852 | ||
Term receivables, long-term | $ | 142,132 | $ | 146,682 | ||
Average days sales outstanding in short-term receivables | 128 days | 101 days | ||||
Average days sales outstanding in short-term receivable, net, excluding the current portion of term receivables | 53 days | 50 days |
The increase in the average days outstanding in short-term accounts receivable, net for the three months ended July 31, 2009 compared to the three months ended January 31, 2009 was due to the decrease in revenue. The decrease in Trade accounts receivable, net for the three months ended July 31, 2009 compared to the three months ended January 31, 2009 was due to decreased billings and improved collections.
Excluding the current portion of term receivables of $152.3 million, average days sales outstanding were 53 as of July 31, 2009. Excluding the current portion of term receivables of $139.1 million, average days sales outstanding were 50 as of January 31, 2009.
The current portion of term receivables 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, although the impact of current economic conditions on our customers could affect this performance. The increase in total term receivables from $285.8 million as of January 31, 2009 to $294.4 million as of July 31, 2009 was primarily due to the timing of billings during the three months ended July 31, 2009 compared to the three months ended January 31, 2009.
We have entered into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. We received net proceeds from the sale of receivables of $17.3 million for the six months ended July 31, 2009 compared to $37.3 million for the six months ended July 31, 2008. We have not set a target for the sale of accounts receivable for the remainder of fiscal 2010.
Accrued Payroll and Related Liabilities
As of | July 31, 2009 | January 31, 2009 | ||||
Accrued payroll and related liabilities | $ | 58,232 | $ | 65,687 |
The decrease in Accrued payroll and related liabilities is primarily due to payments made during the first half of fiscal 2010 (as is typical) resulting in decreases in bonus accruals of approximately $6.9 million and commission accruals of approximately $1.1 million. We generally experience higher accrued payroll and related liability balances at year end primarily due to increased commission accruals associated with an increase in revenues in the fourth quarter. Additionally, we generally experience an increase in bonus accruals at year end which result from a year-to-date true-up of amounts based on the full year achievement of results.
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Investing Activities
Excluding short-term investments, cash used in investing activities for the six months ended July 31, 2009 primarily consisted of cash paid for business acquisitions and capital expenditures.
Expenditures for property, plant, and equipment decreased to $11.0 million for the six months ended July 31, 2009 compared to $19.8 million for the six months ended July 31, 2008. The expenditures for property, plant, and equipment for the six months ended July 31, 2009 were primarily a result of spending on information technology and infrastructure improvements within facilities. We expect total capital expenditures for property, plant, and equipment for fiscal 2010 to be approximately $30.0 million.
During the second quarter of fiscal 2010, we paid $7.1 million for the acquisition of two companies for cash and earn-outs related to prior acquisitions for the six months ended July 31, 2009.
We plan to finance our continued investments in business acquisitions through a combination of cash and common stock issuances. We plan to finance our continued investments in property, plant, and equipment using cash. The cash expected to be utilized includes cash on hand, cash generated from operating activities, and borrowings under the revolving credit facility.
Financing Activities
For the six months ended July 31, 2009, cash used in financing activities consisted primarily of $20 million repaid under the revolving credit facility and $3.5 million for the repurchase of notes payable.
We may elect to purchase or otherwise retire some or all of our 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.
Other factors affecting liquidity and capital resources
6.25% Debentures due 2026
In March 2006, we issued $200.0 million of 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026 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 million shares as of July 31, 2009. 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 thousand principal amount of the 6.25% Debentures a holder will receive an amount of cash equal to the lesser of: (i) $1 thousand 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 thousand, 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 six months ended July 31, 2009, we did not repurchase any 6.25% Debentures and the principal amount of $165.0 million remains outstanding.
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Floating Rate Debentures due 2023
In August 2003, we issued $110.0 million 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 London Interbank Offered Rate (LIBOR) plus 1.65%. The effective interest rate was 2.82% for the six months ended July 31, 2009. 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 1.379 million shares as of July 31, 2009. 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 six months ended July 31, 2009, we repurchased on the open market and retired Floating Rate Debentures with a principal balance of $3.8 million at a discount. As a result, a principal amount of $32.3 million is outstanding as of July 31, 2009.
Revolving Credit Facility
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 $120.0 million to $140.0 million and retained an option to increase it by an additional $10.0 million in the future. In March 2009, we amended the revolving credit facility to reduce the minimum tangible net worth calculated as of January 31, 2009, which is used as the starting point for future calculations, by $15.0 million, and to make certain other changes reflected in the discussion below. 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) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. 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 $107 thousand for the three months ended July 31, 2009 and $184 thousand for the six months ended July 31, 2009 compared to $83 thousand for the three months ended July 31, 2008 and $158 thousand for the six months ended July 31, 2008. This revolving credit facility contains certain financial and other covenants, including the following:
• | Our adjusted quick ratio (ratio of the sum of cash and cash equivalents, short-term investment, and net current receivables to total current liabilities) shall not be less than 0.85; |
• | Our tangible net worth (stockholders’ equity less goodwill and other intangible assets) must exceed the calculated required tangible net worth as defined in the credit agreement, which establishes a fixed level of required tangible net worth. Each quarter the required level increases by 70% of any positive net income in the quarter (but in the aggregate no more than 70% of positive net income for any full fiscal year), 100% of the amortization of intangible assets in the quarter, and 100% of certain stock issuance proceeds. The required level also decreases each quarter by certain amounts of acquired intangible assets; |
• | Our leverage ratio (ratio of total liabilities less subordinated debt to the sum of subordinated debt and tangible net worth) shall not be greater than 2.20; |
• | Our senior leverage ratio (ratio of total debt less subordinated debt to the sum of subordinated debt and tangible net worth) shall be less than 0.90; and |
• | Our minimum cash and accounts receivable ratio (ratio of the sum of cash and cash equivalents, short-term investments, and 47.5% of net current accounts receivable, to outstanding credit agreement borrowings) shall not be less than 1.25. |
The revolving credit facility prevents us from paying dividends.
We were in compliance with all financial covenants as of July 31, 2009. 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 revolving credit facility and our
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lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility. The declaration of an event of default could have a material adverse effect on our financial condition. We could also find it difficult to obtain other bank lines or credit facilities on comparable terms.
We did not borrow any amounts under the revolving credit facility and we repaid $20.0 million during the six months ended July 31, 2009. As of July 31, 2009, we had no balance outstanding against the revolving credit facility. The interest rate was 3.85% as of July 31, 2009.
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 2010
We expect revenues for the third quarter of fiscal 2010 to be approximately $183.0 million with a net loss per share for the same period of approximately $(0.19).
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
All numerical references in tables are in thousands, except for interest rates and contract rates.
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 hold or issue 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 July 31, 2009. 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 | $ | 21,200 | 0.18 | % | ||
Short-term investments – fixed rate | 6 | 6.73 | % | |||
Total fixed rate interest bearing instruments | $ | 21,206 | 0.18 | % | ||
We had convertible subordinated debentures with a principal balance of $165.0 million outstanding with a fixed interest rate of 6.25% as of July 31, 2009. 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 with a principal balance of $32.3 million outstanding with a variable interest rate of 3-month London Interbank Offered Rate (LIBOR) plus 1.65% as of July 31, 2009. 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 $0.3 million.
As of July 31, 2009, 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 $140.0 million. 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) a base rate plus a spread of between 0.0% and 0.6%, based on a pricing grid tied to a financial covenant. The base rate is defined as the higher of: (i) the federal funds rate, as defined, plus 0.5%, (ii) the prime rate of the lead bank, or (iii) one-month LIBOR plus 1.0%. As a result, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. 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. As of July 31, 2009, we had no balance outstanding against this revolving credit facility.
We had other short-term borrowings of $4.2 million outstanding as of July 31, 2009 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 less than $0.1 million.
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 of short-term foreign currency exchange contracts of not more than a year. We enter into contracts with counterparties who are major financial institutions and, as such we do not expect material losses as a result of defaults by our counterparties. We do not hold or issue derivative financial instruments for speculative or trading purposes.
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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.
The following table provides volume information about our foreign currency option program. The information provided is in United States (U.S.) dollar equivalent amounts. The table presents the gross notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These option contracts mature within the next twelve months.
As of | July 31, 2009 | January 31, 2009 | ||||||||
Gross Notional Amount | Weighted Average Contract Rate | Gross Notional Amount | Weighted Average Contract Rate | |||||||
Option Contracts: | ||||||||||
Euro | $ | 62,819 | 0.70 | $ | 97,475 | 0.66 | ||||
Japanese yen | 44,187 | 108.20 | 60,837 | 110.68 | ||||||
British pound | 20,576 | 0.58 | 31,032 | 0.52 | ||||||
Total option contracts | $ | 127,582 | $ | 189,344 | ||||||
We enter into foreign currency forward contracts to protect against currency exchange risk associated with expected future cash flows. Our practice is to hedge a majority of our existing material foreign currency transaction exposures, which generally represent the excess of expected euro and British pound expenses over expected euro and British pound denominated revenues, and the excess of Japanese yen denominated revenue over expected Japanese yen expenses. We also enter into foreign currency forward contracts to protect against currency exchange risk associated with existing assets and liabilities.
The following table provides volume information about our foreign currency forward program. The information provided is in U.S. dollar equivalent amounts. The table presents the gross notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These forward contracts mature within the next twelve months.
As of | July 31, 2009 | January 31, 2009 | ||||||||
Gross Notional Amount | Weighted Average Contract Rate | Gross Notional Amount | Weighted Average Contract Rate | |||||||
Forward Contracts: | ||||||||||
Japanese yen | $ | 54,787 | 93.93 | $ | 45,300 | 94.46 | ||||
Euro | 53,207 | 0.72 | 56,081 | 0.75 | ||||||
British pound | 31,849 | 0.63 | 13,696 | 0.65 | ||||||
Swedish krona | 13,705 | 7.81 | 7,345 | 8.18 | ||||||
Indian rupee | 10,673 | 48.66 | 8,852 | 48.80 | ||||||
Taiwan dollar | 8,257 | 32.75 | 7,221 | 33.37 | ||||||
Korean won | 6,808 | 1,264.60 | 1,494 | 1,376.00 | ||||||
Swiss franc | 3,880 | 1.07 | 3,128 | 1.12 | ||||||
Canadian dollar | 3,382 | 1.12 | 4,152 | 1.25 | ||||||
Israeli shekels | 3,284 | 3.88 | 1,645 | 3.82 | ||||||
Other | 7,493 | — | 6,080 | — | ||||||
Total forward contracts | $ | 197,325 | $ | 154,994 | ||||||
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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, as amended (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 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 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 global economy continues to be weak, with continuing uncertainty in the credit markets and banking systems, reduced corporate profits and capital spending, and significant job losses. A number of our customers are also experiencing liquidity concerns, business insolvencies, and bankruptcies. This volatility and uncertainty about future economic conditions could adversely affect our customers and postpone decisions to license or purchase our products, decrease our customers’ spending, and jeopardize or delay our customers’ ability or willingness to make payment obligations, any of which could adversely affect our business. Consulting spending, which tends to be more discretionary than software and services spending, could be particularly vulnerable to continued economic weakness in our customers’ business. We cannot predict the duration of the global economic downturn or subsequent recovery.
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 may generally take legal action to recover amounts owed, if warranted. 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.
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.
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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. 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 emulation hardware 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 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: Synopsys, Inc. and Cadence Design Systems, 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 half 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. Our cost savings efforts for fiscal 2010 depend on continued strength of the U.S. dollar compared to fiscal 2009 levels, particularly relative to the currencies other than those we hedge (primarily the euro, British pound, and Japanese yen).
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, could harm our operating results.
We may be required to record impairment charges on our 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
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have occurred if the sum of the forecasted undiscounted net 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 July 31, 2009, we had a goodwill balance of $446.8 million and intangible assets of $29.2 million. Going forward, we will continue to review our goodwill and other intangible 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 units would result in the need for us to test for impairment if we determine that the decline is sustained. 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 decline in general economic conditions. These downturns could cause diminished demand for our products and services.
Customer payment defaults could adversely affect our timing of revenue recognition.
We use fixed-term license agreements as standard business practices 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 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.
As a result of the current global economic downturn, our customers may not be able to make future payments as scheduled or may seek to renegotiate pre-existing contractual commitments due to adverse changes in their own businesses. Our customers’ inability to fulfill payment obligations could adversely affect our cash flow. Though we have not, to date, experienced a material level of defaults, our favorable collection experience may not continue and material payment defaults by our customers as a result of current economic conditions or otherwise could have a material adverse effect on our financial condition, results of operations, and cash flow.
During the quarter ended July 31, 2009, one customer accounted for a significant portion of our revenues.
One of our customers accounted for approximately 15% of our total revenues for the three months ended July 31, 2009 and one customer accounted for approximately 11% of our revenues for the six months ended July 31, 2009. If these customers default, declare bankruptcy, or otherwise fails to pay amounts owed, it could have a material adverse effect on our financial condition and results of operations.
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.
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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. 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.
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
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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 (benefit) 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 result in a successful product offering. 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 experienced 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; |
• | 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. |
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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.
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.
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 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. |
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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. 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 in 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 and Oregon law 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 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. The potential issuance of incentive stock and the provisions of the Oregon Control Share Act and the Business Combination Act 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 July 31, 2009, we had $197.0 million of outstanding indebtedness, which includes $32.3 million of Floating Rate Convertible Subordinated Debentures (Floating Rate Debentures) due 2023, $153.4 million of 6.25% Convertible Subordinated Debentures (6.25% Debentures) due 2026, and $11.3 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. |
Unless repurchased earlier by the Company, the Floating Rate Debentures will be reclassified on our balance sheet from long-term liabilities to short-term liabilities in the third quarter of fiscal 2010 as a result of the Debenture holders having the option to redeem their Debentures on or after August 6, 2010.
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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. 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.
Our revolving credit facility has financial and non-financial covenants, and default of any covenant could materially adversely impact us.
Our bank revolving 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. 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 revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility. The declaration of an event of default could have a material adverse effect on our financial condition. We could also find it difficult to obtain other bank lines or credit facilities on comparable terms.
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Item 4. | Submission of Matters to a Vote of Security Holders |
Our 2009 Annual Meeting of Shareholders was held pursuant to notice at 5:00 p.m. Pacific time on June 25, 2009 at our offices in Wilsonville, Oregon to consider and vote upon:
Proposal 1 | To elect directors to serve for the ensuing year and until their successors are elected; | |
Proposal 2 | To amend the Company’s 1989 Employee Stock Purchase Plan and Foreign Subsidiary Employee Stock Purchase Plan to increase the number of shares reserved for issuance under each of the plans; and | |
Proposal 3 | To ratify the appointment of KPMG LLP as the Company’s independent registered public accounting firm for the fiscal year ending January 31, 2010. |
The results of the voting on these proposals were as follows:
Proposal 1 Election of Directors | For | Withheld | ||
Marsha B. Congdon | 65,840,235 | 24,640,170 | ||
Gregory K. Hinckley | 85,476,773 | 5,003,632 | ||
Kevin C. McDonough | 64,765,527 | 25,714,878 | ||
Walden C. Rhines | 85,357,800 | 5,122,605 | ||
Fontaine K. Richardson | 59,726,381 | 30,754,024 | ||
Sir Peter Bonfield | 40,819,178 | 49,661,227 | ||
James R. Fiebiger | 85,237,819 | 5,242,586 | ||
Patrick B. McManus | 65,846,003 | 24,634,402 |
For | Against | Abstentions | Broker Non-Votes | |||||
Proposal 2 | 75,438,412 | 3,860,794 | 1,149,454 | 10,031,748 | ||||
Proposal 3 | 90,059,912 | 368,609 | 51,887 | — |
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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: September 4, 2009 | MENTOR GRAPHICS CORPORATION (Registrant) | |
/S/ GREGORY K. HINCKLEY | ||
Gregory K. Hinckley | ||
President, Chief Financial Officer |
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