UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2002
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 NUMBER: 0-19807
----------------
SYNOPSYS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1546236
-------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
700 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(Address of principal executive offices)
TELEPHONE: (650) 584-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13, or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
76,293,192 shares of Common Stock as of June 7, 2002
SYNOPSYS, INC.
QUARTERLY REPORT ON FORM 10-Q
APRIL 30, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS..................................................3
CONDENSED CONSOLIDATED BALANCE SHEETS.................................3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME.................4
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS..........................................................5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS........6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................................14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK............30
PART II.OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.....................................30
SIGNATURES...................................................................30
2
PART I
ITEM 1. FINANCIAL STATEMENTS
SYNOPSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
APRIL 30, OCTOBER 31,
2002 2001
------------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 483,570 $ 271,696
Short-term investments 48,170 204,740
-------------- -------------
Total cash and short-term investments 531,740 476,436
Accounts receivable, net of allowances of
$10,912 and $11,027, respectively 151,953 146,294
Deferred taxes 152,486 149,239
Prepaid expenses and other 30,919 19,413
-------------- -------------
Total current assets 867,098 791,382
Property and equipment, net 194,225 192,304
Long-term investments 54,634 61,699
Intangible assets, net 26,974 35,077
Other assets 53,358 48,445
-------------- -------------
Total assets $ 1,196,289 $ 1,128,907
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 108,741 $ 135,272
Current portion of long-term debt 515 535
Accrued income taxes 55,756 110,561
Deferred revenue 327,319 290,052
-------------- -------------
Total current liabilities 492,331 536,420
-------------- -------------
Deferred compensation and other liabilities 23,392 17,124
Long-term deferred revenue 69,545 89,707
Stockholders' equity:
Preferred stock, $.01 par value; 2,000 shares
authorized; no shares outstanding -- --
Common stock, $.01 par value; 400,000 shares
authorized; 61,637 and 59,428 shares
outstanding, respectively 616 595
Additional paid-in capital 588,595 575,403
Retained earnings 451,318 436,662
Treasury stock, at cost (434,937) (531,117)
Accumulated other comprehensive income 5,429 4,113
-------------- -------------
Total stockholders' equity 611,021 485,656
-------------- -------------
Total liabilities and stockholders' equity $ 1,196,289 $ 1,128,907
============== =============
The accompanying notes are an integral part of these financial statements.
3
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenue:
Product $ 52,293 $ 33,102 $ 91,848 $ 72,294
Service 65,765 91,501 134,858 178,470
Ratable license 67,580 38,921 134,477 69,914
----------- ----------- ----------- -----------
Total revenue 185,638 163,524 361,183 320,678
----------- ----------- ----------- -----------
Cost of revenue:
Product 3,221 4,956 7,287 9,546
Service 17,391 19,922 38,075 40,290
Ratable license 13,780 6,078 24,220 13,175
----------- ----------- ----------- -----------
Total cost of revenue 34,392 30,956 69,582 63,011
----------- ----------- ----------- -----------
Gross margin 151,246 132,568 291,601 257,667
Operating expenses:
Research and development 46,649 47,636 95,355 93,857
Sales and marketing 63,201 69,202 123,000 138,781
General and administrative 17,537 15,104 36,245 31,793
Amortization of intangible assets 4,356 4,179 8,400 8,351
----------- ----------- ----------- -----------
Total operating expenses 131,743 136,121 263,000 272,782
----------- ----------- ----------- -----------
Operating (loss) income 19,503 (3,553) 28,601 (15,115)
Other income, net 11,213 21,921 22,294 47,402
----------- ----------- ----------- -----------
Income before provision for income taxes 30,716 18,368 50,895 32,287
Provision for income taxes 9,336 5,878 15,463 10,332
----------- ----------- ----------- -----------
Net income $ 21,380 $ 12,490 $ 35,432 $ 21,955
=========== =========== =========== ===========
Basic earnings per share $ 0.35 $ 0.21 $ 0.58 $ 0.35
=========== =========== =========== ===========
Weighted average common shares outstanding 61,232 60,776 60,670 62,822
=========== =========== =========== ===========
Diluted earnings per share $ 0.33 $ 0.19 $ 0.55 $ 0.33
=========== =========== =========== ===========
Weighted average common shares
and dilutive stock options outstanding 64,934 65,384 64,956 66,836
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
SIX MONTHS ENDED
APRIL 30,
--------------------------
2002 2001
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 35,432 $ 21,955
Adjustments to reconcile net income to net cash flows
(used in) provided by operating activities:
Depreciation and amortization 34,266 31,991
Tax benefit associated with stock options 12,222 8,496
Provision for doubtful accounts and sales returns 1,767 1,237
Interest accretion on notes payable -- 276
Deferred rent 1,736 56
Deferred taxes (3,191) --
Gain on sale of long-term investments (11,062) (29,553)
Write-down of long-term investments 3,500 4,348
Gain on sale of silicon libraries business -- (10,580)
Net changes in operating assets and liabilities:
Accounts receivable (7,426) 12,921
Prepaid expenses and other current assets (11,506) 964
Other assets (5,993) (505)
Accounts payable and accrued liabilities (26,931) (38,815)
Accrued income taxes (54,805) (14,160)
Deferred revenue 17,105 106,723
Deferred compensation 5,256 1,567
------------- -------------
Net cash (used in) provided by operating activities (9,630) 96,921
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (26,542) (33,592)
Purchases of short-term investments (504,788) (1,213,513)
Proceeds from sales and maturities of short-term investments 659,931 1,248,923
Purchases of long-term investments (3,205) (8,500)
Proceeds from sale of long-term investments 20,024 47,773
Proceeds from the sale of silicon libraries business -- 4,122
Intangible assets, net -- (252)
Capitalization of software development costs (796) (500)
------------- -------------
Net cash (used in) provided by investing activities 144,624 44,461
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations -- (5,068)
Issuances of common stock 76,395 65,302
Purchases of treasury stock -- (206,320)
------------- -------------
Net cash provided by (used in) financing activities 76,395 (146,086)
Effect of exchange rate changes on cash 485 (2,826)
------------- -------------
Net increase (decrease) in cash and cash equivalents 211,874 (7,530)
Cash and cash equivalents, beginning of period 271,696 153,120
------------- -------------
Cash and cash equivalents, end of period $ 483,570 $ 145,590
============= =============
The accompanying notes are an integral part of these financial statements.
5
SYNOPSYS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF COMPANY AND BASIS OF PRESENTATION
Synopsys, Inc. (Synopsys or the Company) is a leading supplier of electronic
design automation (EDA) software to the global electronics industry. The Company
develops, markets, and supports a wide range of integrated circuit (IC) design
products that are used by designers of advanced ICs, including system-on-a-chip
ICs, and the electronic systems (such as computers, cell phones, and internet
routers) that use such ICs, to automate significant portions of their design
process. ICs are distinguished by the speed at which they run, their area, the
amount of power they consume and their cost of production. Synopsys' products
offer its customers the opportunity to design ICs that are optimized for speed,
area, power consumption and production cost, while reducing overall design time.
The Company also provides consulting services to help its customers improve
their IC design processes and, where requested, to assist them with their IC
designs, as well as training and support services.
The Company's fiscal year ends on the Saturday nearest October 31. Fiscal
year 2001 was a 53-week year with the extra week added to the first quarter and
fiscal year 2002 will be a 52-week year. For presentation purposes, the
unaudited condensed consolidated financial statements and notes refer to the
calendar month end.
The unaudited condensed consolidated financial statements include the
accounts of Synopsys and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the financial position and results of
operations of the Company have been made. Operating results for the interim
periods are not necessarily indicative of the results that may be expected for
any future period or the full fiscal year. The unaudited condensed consolidated
financial statements and notes included herein should be read in conjunction
with the consolidated financial statements and notes thereto for the fiscal year
ended October 31, 2001 included in the Company's 2001 Annual Report on Form
10-K.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the unaudited condensed
consolidated financial statements and accompanying notes. A change in the facts
and circumstances surrounding these estimates and assumptions could result in a
change to the estimates and assumptions and impact future operating results.
2. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION AND COST OF REVENUE
Revenue consists of fees for perpetual and time-based licenses for the
Company's software products, sales of hardware system products, post-contract
customer support (PCS), customer training and consulting. The Company classifies
its revenues as product, service or ratable license. Product revenue consists
primarily of sales of perpetual licenses.
Service revenue consists of fees for consulting services, training, and PCS
associated with non-ratable time-based licenses or perpetual licenses. PCS sold
with perpetual licenses is generally renewable, after any bundled PCS period
expires, in one year increments for a fixed percentage of the perpetual list
price, or, for perpetual license arrangements in excess of $2 million, as a
percentage of the net license fee.
Ratable license revenue is all fees related to time-based licenses bundled
with PCS and sold as a single package (commonly referred to by the Company as a
Technology Subscription License or TSL), and time-based licenses that include
extended payment terms or unspecified additional products.
Cost of product revenue includes cost of production personnel, product
packaging, documentation, amortization of capitalized software development
costs, and costs of the Company's systems products. Cost of service revenue
includes personnel and the related costs associated with providing training,
consulting and PCS. Cost of ratable license revenue includes the cost of
products and services related to time-based licenses bundled with PCS and sold
as a single package and to time-based licenses that include extended payment
terms or unspecified additional products.
6
The Company recognizes revenue in accordance with SOP 97-2, SOFTWARE REVENUE
RECOGNITION, as amended by SOP 98-9 and SOP 98-4, and generally recognizes
revenue when all of the following criteria are met as set forth in paragraph 8
of SOP 97-2:
o Persuasive evidence of an arrangement exists,
o Delivery has occurred,
o The vendor's fee is fixed or determinable, and
o Collectibility is probable.
The Company defines each of the four criteria above as follows:
PERSUASIVE EVIDENCE OF AN ARRANGEMENT EXISTS. It is the Company's customary
practice to have a written contract, which is signed by both the customer
and Synopsys, or a purchase order from those customers that have previously
negotiated a standard end-user license arrangement or volume purchase
agreement, prior to recognizing revenue on an arrangement.
DELIVERY HAS OCCURRED. The Company's software may be either physically or
electronically delivered to its customers. For those products that are
delivered physically, the Company's standard transfer terms are FOB shipping
point. For an electronic delivery of software, delivery is considered to
have occurred when the customer has been provided with the access codes that
allow the customer to take immediate possession of the software on its
hardware.
If undelivered products or services exist in an arrangement that are
essential to the functionality of the delivered product, delivery is not
considered to have occurred.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. The fee the Company's customers
pay for its products is negotiated at the outset of an arrangement, and is
generally based on the specific volume of products to be delivered. The
Company's license fees are not a function of variable-pricing mechanisms
such as the number of units distributed or copied by the customer, or the
expected number of users in an arrangement. Therefore, except in cases where
the Company grants extended payment terms to a specific customer, the
Company's fees are considered to be fixed or determinable at the inception
of its arrangements.
The Company's customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. Arrangements with payment
terms extending beyond the customary payment terms are considered not to be
fixed or determinable. Revenue from such arrangements is recognized at the
lesser of the aggregate of amounts due and payable or the amount of the
arrangement fee that would have been recognized if the fees had been fixed
or determinable.
COLLECTIBILITY IS PROBABLE. Collectibility is assessed on a
customer-by-customer basis. The Company typically sells to customers for
which there is a history of successful collection. New customers are
subjected to a credit review process, which evaluates the customers'
financial positions and, ultimately, their ability to pay. New customers are
typically assigned a credit limit based on a formulated review of their
financial position. Such credit limits are only increased after a successful
collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not
probable based upon the Company's credit review process, revenue is
recognized on a cash-collected basis.
MULTIPLE-ELEMENT ARRANGEMENTS. The Company allocates revenue on software
arrangements involving multiple elements to each element based on the relative
fair values of the elements. The Company's determination of fair value of each
element in multiple-element arrangements is based on vendor-specific objective
evidence (VSOE). The Company limits its assessment of VSOE for each element to
the price charged when the same element is sold separately.
The Company has analyzed all of the elements included in its
multiple-element arrangements and determined that it has sufficient VSOE to
allocate revenue to the PCS components of its perpetual license products and
consulting. Accordingly, assuming all other revenue recognition criteria are
met, revenue from perpetual licenses is recognized upon delivery using the
residual method in accordance with SOP 98-9, and revenue from PCS is recognized
ratably over the PCS term. The Company recognizes revenue from TSLs over the
term of the ratable license period, as the license and PCS portions of a TSL are
bundled and not sold separately. Revenue from contracts with extended payment
terms is recognized as the lesser of amounts due and payable or the amount of
the arrangement fee that would have been recognized if the fee were fixed or
determinable.
7
Certain of the Company's time-based licenses include unspecified additional
products. Revenue from contracts with unspecified additional software products
is recognized ratably over the contract term. The Company recognizes revenue
from time-based licenses that include both unspecified additional software
products and extended payment terms that are not considered to be fixed or
determinable in an amount that is the lesser of amounts due and payable or the
ratable portion of the entire fee.
CONSULTING SERVICES. The Company provides design methodology assistance,
specialized services relating to telecommunication systems design and turnkey
design services. The Company's consulting services generally are not essential
to the functionality of the software. The Company's software products are fully
functional upon delivery and implementation does not require any significant
modification or alteration. The Company's services to its customers often
include assistance with product adoption and integration and specialized design
methodology assistance. Customers typically purchase these professional services
to facilitate the adoption of the Company's technology and dedicate personnel to
participate in the services being performed, but they may also decide to use
their own resources or appoint other professional service organizations to
provide these services. Software products are billed separately and
independently from consulting services, which are generally billed on a
time-and-materials or milestone-achieved basis. The Company generally recognizes
revenue from consulting services as the services are performed.
Exceptions to the general rule above involve arrangements where the Company
has committed to significantly alter the features and functionality of its
software or build complex interfaces necessary for the Company's software to
function in the customer's environment. These types of services are considered
to be essential to the functionality of the software. Accordingly, contract
accounting is applied to both the software and service elements included in
these arrangements.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, BUSINESS COMBINATIONS (SFAS 141), and
No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 and specifies criteria intangible assets acquired
in a purchase method business combination must meet to be recognized apart from
goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead be tested for impairment at
least annually in accordance with the provisions of SFAS 142.
The Company adopted the provisions of SFAS 141 on July 1, 2001. Under SFAS
141, goodwill and intangible assets with indefinite useful lives acquired in a
purchase business combination completed after June 30, 2001, but before SFAS 142
is adopted, will not be amortized but will continue to be evaluated for
impairment in accordance with SFAS 121. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized and tested for impairment in accordance with current accounting
guidance until the date of adoption of SFAS 142.
Upon adoption of SFAS 142, the Company must evaluate its existing intangible
assets and goodwill acquired in purchase business combinations prior to July 1,
2001, and make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, the Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments. The Company will also be required to test goodwill for
impairment in accordance with the provisions of SFAS 142 within the six-month
period following adoption. Any impairment loss will be measured as of the date
of adoption and recognized immediately as the cumulative effect of a change in
accounting principle. Any subsequent impairment losses will be included in
operating activities.
The Company expects to adopt SFAS 142 on November 1, 2002. As of April 30,
2002, unamortized goodwill is $27.0 million which, in accordance with the
Statements, will continue to be amortized until the date of adoption of SFAS
142. Amortization of goodwill for the six-month period ended April 30, 2002 is
$7.9 million. The Company does not have any intangible assets with an indefinite
useful life. Because of the extensive effort needed to comply with adopting SFAS
142, it is not practicable to reasonably estimate the impact of adopting this
Statement on the Company's financial statements at the date of this report,
including whether the Company will be required to recognize any transitional
impairment losses.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS (SFAS 143). SFAS 143 requires that asset retirement obligations that
are identifiable upon acquisition, construction or development and during the
operating life of a long-lived asset be recorded as a liability using the
present value of the estimated cash flows. A corresponding amount would be
capitalized as part of the asset's carrying amount and amortized to expense over
the asset's useful life. The Company is required to adopt the provisions of SFAS
143 effective November 1, 2002. The Company is currently evaluating the impact
of adoption of this Statement on its financial position and results of
operations.
8
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS (SFAS 144), which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED OF, and the accounting and reporting provisions
of APB Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS FOR A DISPOSAL OF A
SEGMENT OF A BUSINESS. The Company is required to adopt the provisions of SFAS
144 no later than November 1, 2002. The Company does not expect that the
adoption of SFAS 144 will have a significant impact on its financial position
and results of operations.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to current year
presentation.
3. STOCK REPURCHASE PROGRAM
In July 2001, the Company's Board of Directors authorized a stock repurchase
program under which Synopsys common stock with a market value up to $500 million
may be acquired in the open market. This stock repurchase program replaced all
prior repurchase programs authorized by the Board. Common shares repurchased are
intended to be used for ongoing stock issuances under the Company's employee
stock plans and for other corporate purposes. The July 2001 stock repurchase
program expires on October 31, 2002. During the three-month and six-month
periods ended April 30, 2001, the Company purchased 1.2 million and 4.2 million
shares, respectively, of Synopsys common stock in the open market under a prior
stock repurchase program, at average prices of $52 per share and $49 per share,
respectively. The Company did not repurchase any shares during the three-month
and six-month periods ended April 30, 2002. At April 30, 2002, approximately
$481.9 million remained available for repurchases under the July 2001 program.
4. COMPREHENSIVE INCOME
The following table sets forth the components of comprehensive income, net
of income tax expense:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
----------------------- --------------------------
2002 2001 2002 2001
----------- ----------- ------------ -------------
(IN THOUSANDS)
Net income $ 21,380 $ 12,490 $ 35,432 $ 21,955
Foreign currency translation adjustment (2,113) 1,262 454 (2,826)
Unrealized gain (loss) on investments 1,032 (6,039) 6,704 (20,138)
Reclassification adjustment for realized
gains on investments (2,873) (9,363) (5,842) (1,128)
----------- ----------- ------------ -------------
Total comprehensive income (loss) $ 17,426 $ (1,650) $ 36,748 $ (2,137)
=========== =========== ============ =============
5. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted-average number of common shares and dilutive
employee stock options outstanding during the period. The weighted-average
dilutive stock options outstanding is computed using the treasury stock method.
9
The following is a reconciliation of the weighted-average common shares used
to calculate basic net earnings per share to the weighted-average common shares
used to calculate diluted net income per share:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
--------------------------- --------------------
2002 2001 2002 2001
------------- ------------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NUMERATOR
Net income $ 21,380 $ 12,490 $ 35,432 $ 21,955
============= =========== =========== ==========
DENOMINATOR:
Weighted-average common shares
outstanding 61,232 60,776 60,670 62,822
Effect of dilutive employee stock options 3,702 4,608 4,286 4,014
------------- ----------- ----------- ----------
Diluted common shares 64,934 65,384 64,956 66,836
============ =========== =========== =========
Basic earnings per share $ 0.35 $ 0.21 $ 0.58 $ 0.35
============= =========== =========== ==========
Diluted earnings per share $ 0.33 $ 0.19 $ 0.55 $ 0.33
============= =========== =========== ==========
The effect of dilutive employee stock options excludes approximately
5,511,000 and 2,720,000 stock options for the three-month periods ended April
30, 2002 and 2001, respectively, and 4,623,000 and 3,276,000 stock options for
the six-month periods ended April 30, 2002 and 2001, respectively, which were
anti-dilutive for earnings per share calculations.
6. SEGMENT DISCLOSURE
Statement of Financial Accounting Standards 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. The method for
determining what information to report under SFAS 131 is based upon the
"management approach," or the way that management organizes the operating
segments within a Company for which separate financial information is available
that is evaluated regularly by the Chief Operating Decision Maker (CODM) in
deciding how to allocate resources and in assessing performance. Synopsys' CODM
is the Chief Executive Officer and Chief Operating Officer.
The Company provides comprehensive design technology products and consulting
services in the EDA software industry. The CODM evaluates the performance of the
Company based on profit or loss from operations before income taxes not
including merger-related costs, in-process research and development and
amortization of intangible assets. For the purpose of making operating
decisions, the CODM primarily considers financial information presented on a
consolidated basis accompanied by disaggregated information about revenues by
geographic region. There are no differences between the accounting policies used
to measure profit and loss for the Company segment and those used on a
consolidated basis. Revenue is defined as revenues from external customers.
The disaggregated financial information reviewed by the CODM is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(IN THOUSANDS)
Revenue:
Product $ 52,293 $ 33,102 $ 91,848 $ 72,294
Service 65,765 91,501 134,858 178,470
Ratable license 67,580 38,921 134,477 69,914
----------- ----------- ----------- -----------
Total revenue $ 185,638 $ 163,524 $ 361,183 $ 320,678
=========== =========== =========== ===========
Gross margin $ 151,246 $ 132,568 $ 291,601 $ 257,667
Operating income (loss) before amortization
of intangible assets, and in-process research
and development $ 23,859 $ 626 $ 37,001 $ (6,764)
There were no merger related or in-process research and development costs in
the periods presented.
10
Reconciliation of the Company's segment profit and loss to the Company's
operating income (loss) before provision for income taxes is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
--------------------- ------------------------
2002 2001 2002 2001
---------- ---------- ------------ ------------
(IN THOUSANDS)
Operating income (loss) before amortization of
intangible assets $ 23,859 $ 626 $ 37,001 $ (6,764)
Amortization of intangible assets (4,356) (4,179) (8,400) (8,351)
---------- ---------- ------------ ------------
Operating income (loss) $ 19,503 $ (3,553) $ 28,601 $ (15,115)
========== ========== ============ ============
Revenue and long-lived assets related to operations in the United States and
other geographic areas are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
------------------------ ---------------------
2002 2001 2002 2001
----------- ----------- ------------ ------------
(IN THOUSANDS)
Revenue:
United States $ 127,319 $ 101,111 $ 236,028 $ 195,915
Europe 29,524 30,269 63,592 57,719
Japan 17,007 17,779 34,025 34,655
Other 11,788 14,365 27,538 32,389
----------- ------------- -------------- --------------
Consolidated $ 185,638 $ 163,524 $ 361,183 $ 320,678
=========== ============= ============== =============
APRIL 30, OCTOBER 31,
2002 2001
---------------- -----------------
(IN THOUSANDS)
Long-lived assets:
United States $ 178,574 $ 176,330
Other 15,651 15,974
---------------- -----------------
Consolidated $ 194,225 $ 192,304
================ =================
Geographic revenue data for multi-region, multi-product transactions reflect
internal allocations and is therefore subject to certain assumptions and to the
Company's methodology. Revenue is not reallocated among geographic regions to
reflect any re-mixing of licenses between different regions following the
initial product shipment. No one customer accounted for more than ten percent of
the Company's consolidated revenue in the periods presented.
The Company segregates revenue into five categories for purposes of internal
management reporting: IC Implementation, including both the Design Compiler (DC)
Family and Physical Synthesis; Verification and Test; Intellectual Property (IP)
and System Level Design; Transistor Level Design; and Professional Services.
Revenue for each of the categories is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
------------------------- --------------------
2002 2001 2002 2001
----------- ---------- --------- ----------
(IN THOUSANDS)
Revenue:
IC Implementation
DC Family $ 58,260 $ 53,578 $ 113,748 $ 107,423
Physical Synthesis 20,327 10,495 35,364 16,655
Verification and Test 56,560 45,321 113,506 89,543
IP and System Level Design 19,972 19,938 39,773 38,379
Transistor Level Design 15,072 10,730 29,832 24,195
Professional Services 15,447 23,462 28,960 44,483
----------- ----------- ----------- ----------
Consolidated $ 185,638 $ 163,524 $ 361,183 $ 320,678
=========== =========== =========== ==========
11
7. DERIVATIVE FINANCIAL INSTRUMENTS
Available-for-sale equity investments accounted for under Statement of
Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES, (SFAS 115) are subject to market price risk. From
time to time, the Company enters into and designates forward contracts to hedge
variable cash flows from anticipated sales of these investments. The Company
recorded a net realized gain on the sale of the available-for-sale investments
including the settlement of forward contracts of $6.8 million and $15.3 million,
respectively, during the three-month periods ended April 30, 2002 and 2001 and
$12.4 million and $28.8 million, respectively, during the six-month periods
ended April 30, 2002 and 2001 (net of premium amortization). As of April 30,
2002, the Company has recorded $17.9 million in long-term investments due to
locked-in unrealized gains on the available-for-sale investments. As of April
30, 2002, the maximum length of time over which the Company is hedging its
exposure to the variability in future cash flows associated with the forward
sale contracts is 12 months.
8. TERMINATION OF AGREEMENT TO ACQUIRE IKOS SYSTEMS, INC.
On July 2, 2001, the Company entered into an Agreement and Plan of Merger
with IKOS Systems, Inc. (IKOS). The Agreement provided for the acquisition of
all outstanding shares of IKOS common stock by Synopsys.
On December 7, 2001, Mentor Graphics Corporation (Mentor) commenced a cash
tender offer to acquire all of the outstanding shares of IKOS common stock at
$11.00 per share, subject to certain conditions. On March 12, 2002, Synopsys and
IKOS executed a termination agreement by which the parties terminated the
Synopsys-IKOS merger agreement and pursuant to which IKOS paid Synopsys the $5.5
million termination fee required under the Synopsys-IKOS merger agreement. This
termination fee and $2.4 million of expenses incurred in conjunction with the
acquisition are included in other income, net on the unaudited condensed
consolidated statement of income. Synopsys subsequently executed a revised
termination agreement with Mentor and IKOS in order to add Mentor as a party
thereto.
9. WORKFORCE REDUCTION
In March 2002, the Company implemented a workforce reduction. The purpose
was to reduce expenses by decreasing the number of employees in all departments,
both domestically and internationally. As a result, the Company's workforce was
decreased by approximately 175 employees and a charge of approximately $3.9
million is included in operating expenses during the second quarter of fiscal
2002. This charge consists of severance and other special termination benefits.
10. SUBSEQUENT EVENT - ACQUISITION OF AVANT! CORPORATION
On June 6, 2002 (the "closing date"), the Company completed the merger with
Avant! Corporation (Avant!), a company which develops, markets, licenses and
supports electronic design automation software products that assist design
engineers in the physical layout, design, verification, simulation, timing and
analysis of advanced integrated circuits. Under the terms of the merger
agreement between the Company and Avant!, Avant! merged with and into a
wholly-owned subsidiary of Synopsys. The merger will be accounted for under the
purchase method of accounting. The results of operations of Avant! are not
included in the accompanying condensed consolidated financial statements because
the merger occurred subsequent to the date of the Company's balance sheet.
REASONS FOR THE ACQUISITION. The Synopsys Board of Directors unanimously
approved the merger agreement at its December 1, 2001 meeting. In approving the
merger agreement and making these determinations and recommendations, the Board
of Directors consulted with legal and financial advisors as well as with
management and considered a number of factors. These factors include the fact
that the merger is expected to enable Synopsys and Avant! to offer their
semiconductor customers a complete end-to-end solution for system-on-chip design
that includes Synopsys' logic synthesis and design verification tools with
Avant!'s advanced place and route, physical verification and design integrity
products, thus increasing customers' design efficiencies. By increasing customer
design efficiencies, Synopsys expects to be able to better compete for customers
designing the next generation of semiconductors. Further, by gaining access to
Avant!'s physical design and verification products, as well as its broad
customer base and relationships, Synopsys will gain new opportunities to market
its existing products. The foregoing discussion of the information and factors
considered by the Synopsys Board of Directors is not intended to be exhaustive
but includes the material factors considered by the Synopsys Board of Directors.
12
PURCHASE PRICE. Holders of Avant! common stock received 0.371 of a share of
Synopsys common stock (including the associated preferred stock rights) in
exchange for each share of Avant! common stock (the exchange ratio) owned as of
the closing date, aggregating 14.5 million shares of Synopsys common stock. The
fair value of the Synopsys shares issued was based on a per share value of
$54.74, which is equal to Synopsys' average last sale price per share as
reported on the Nasdaq National Market for the trading-day period two days
before and after December 3, 2001, the date of the merger agreement.
The purchase consideration will include (a) the fair value of Synopsys
common stock issued of approximately $795.4 million, (b) the estimated fair
value of options to purchase Synopsys common stock to be issued, less the
portion of the intrinsic value of Avant!'s unvested options applicable to the
remaining vesting period, the determination of which amount is not complete as
of the date of this filing, (c) estimated merger related costs of approximately
$25 million, (d) employee severance costs, and (e) restructuring charges related
to exiting certain of Avant!'s activities, including certain facilities, and
workforce reductions, in accordance with Emerging Issues Task Force (EITF) Issue
No. 95-3.
The estimated merger-related costs consist primarily of banking, legal and
accounting fees, printing costs, and other directly related charges.
Employee severance costs consist of a cash severance payment due upon the
closing of the merger of $41.8 million to Avant!'s Chairman of the Board and
cash severance payments to other employees of Avant!, the determination of which
amount is not complete as of the date of this filing.
As of the date of filing this Form 10-Q, the valuation of Avant!'s assets
and liabilities, including identifiable intangible assets, as of the closing
date has not been completed. Furthermore, completion of integration planning
will result in additional accruals for severance costs and/or facilities
closures. Such accruals will increase the purchase consideration and the
allocation of the purchase consideration to goodwill. Due to acceleration
provisions related to certain of Avant!'s stock options and the completion of
the integration planning, including workforce reductions, the estimated fair
value of options to purchase Synopsys common stock to be issued in the merger
has not been determined as of the date of this filing.
CADENCE LITIGATION. In connection with the merger, Synopsys has entered into
a policy with a subsidiary of American International Group, Inc., a AAA rated
insurance company, whereby insurance has been obtained for certain compensatory,
exemplary and punitive damages, penalties and fines and attorneys' fees arising
out of pending litigation between Avant! and Cadence Design Corporation, Inc.
(the "Avant!/Cadence litigation" or the "covered loss"). The Avant!/Cadence
litigation is described in the section entitled "Factors that May Affect Future
Results". The policy does not provide coverage for litigation other than the
Avant!/Cadence litigation.
In return for a premium of $335 million, the insurer will be obligated to
pay covered loss up to a limit of liability equaling (a) $500 million plus (b)
interest accruing at the fixed rate of 2%, compounded semi-annually, on $250
million (the "interest component"), as reduced by previous covered losses. The
policy will expire following a final judgment or settlement of the
Avant!/Cadence litigation or any earlier date upon Synopsys' election. Upon such
expiration, Synopsys will be entitled to a payment equal to $240 million plus
the interest component less any covered loss (which, for this purpose, shall
include legal fees only to the extent that the aggregate amount of such fees
exceeds $10 million).
The contingently refundable portion of the insurance premium ($240 million)
will be included in the post-merger balance sheet as a long-term restricted
asset. Interest earned on that amount will be included in other income, net in
the post-merger statement of operations. The balance of the premium paid to the
insurer ($95 million) will be recognized as expense in the third quarter of
fiscal 2002.
At the closing date, the Avant!/Cadence litigation has been accounted for as
a pre-merger contingency because a litigation judgment or settlement amount, if
any, is not probable or estimable. If a litigation loss becomes probable and
estimable after the date of the merger, such loss will be included in net
income.
13
GOODWILL AND INTANGIBLE ASSETS. Goodwill, representing the excess of the
purchase price over the fair value of tangible and identifiable intangible
assets, acquired in the merger will not be amortized, consistent with the
guidance with SFAS 142. Upon completion of the valuation of Avant!'s assets and
liabilities, including identifiable intangible assets, any resulting allocation
to acquired in-process research and development will be reflected in the
post-merger statement of income. In addition, a portion of the purchase price
will be allocated to identifiable intangible assets, including the following:
Intangible Asset Estimated Useful Life
-----------------------------------------------------------------------
Core/developed technology 3 years
Contract right intangible 3 years
Customer installed base/relationship 6 years
Trademarks and tradenames 3 years
Covenants not to compete The life of the related agreement
(2 to 4 years)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. Such
forward-looking statements include the statements concerning the effect of
Technology Subscription Licenses on our revenue, expectations for revenue and
costs of revenue, expectations about gains from the sale of investments, effects
of foreign currency hedging, adequacy of our cash as well as statements
including the words "projects," "expects," "believes," "anticipates", "will" or
similar expressions. Actual results could differ materially from those
anticipated in such forward-looking statements as a result of certain factors,
including those set forth under "Factors That May Affect Future Results."
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to revenue recognition, bad debts, investments, intangible assets
and income taxes. Our estimates are based on historical experience and on
various other assumptions we believe are reasonable under the circumstances.
Actual results may differ from these estimates.
The accounting policies described below are the ones that most frequently
require us to make estimates and judgments, and are therefore critical to
understanding our results of operations.
REVENUE RECOGNITION AND COST OF REVENUE. Our revenue recognition policy is
detailed in Note 2 of the Notes to Unaudited Condensed Consolidated Financial
Statements. Management has made significant judgments related to revenue
recognition; specifically, evaluating whether our fee relating to an arrangement
is fixed or determinable and assessing whether collectibility is probable. These
judgments are discussed below.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. In order to recognize revenue, we
must make a judgment as to whether the arrangement fee is fixed or determinable.
Except in cases where we grant extended payment terms to a specific customer, we
have determined that our fees are fixed or determinable at the inception of our
arrangements based on the following:
o The fee our customers pay for our products is negotiated at the
outset of an arrangement and is generally based on the specific
volume of products to be delivered.
o Our license fees are not a function of variable-pricing
mechanisms such as the number of units distributed or copied by
the customer or the expected number of users of the product
delivered.
Our customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. These customary payment terms
are supported by historical practice and concessions have not been granted to
customers under this policy. Arrangements with payment terms extending beyond
the customary payment terms are considered not to be fixed or determinable.
Revenue from such arrangements is recognized at the lesser of the aggregate of
amounts due and payable or the amount of the arrangement fee that would have
been recognized if the fees had been fixed or determinable.
14
COLLECTIBILITY IS PROBABLE. In order to recognize revenue, we must make a
judgment of the collectibility of the arrangement fee. Our judgment of the
collectibility is applied on a customer-by-customer basis pursuant to our credit
review policy. We typically sell to customers for which there is a history of
successful collection. New customers are subjected to a credit review process,
which evaluates the customers' financial positions and ability to pay. New
customers are typically assigned a credit limit based on a formulated review of
their financial position. Such credit limits are only increased after a
successful collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not probable
based upon our credit review process, revenue is recognized on a cash-collected
basis.
VALUATION OF STRATEGIC INVESTMENTS. As of April 30, 2002, the adjusted cost
of our strategic investments totaled $29.3 million. We review our investments in
non-public companies and estimate the amount of any impairment incurred during
the current period based on specific analysis of each investment, considering
the activities of and events occurring at each of the underlying portfolio
companies during the quarter. Our portfolio companies operate in industries that
are rapidly evolving and extremely competitive. For equity investments in
non-public companies for which there is not a market in which their value is
readily determinable, we assess each investment for indicators of impairment at
each quarter end based primarily on achievement of business plan objectives and
current market conditions, among other factors, and information available to us
at the time of this quarterly assessment. The primary business plan objectives
we consider include, among others, those related to financial performance such
as achievement of planned financial results or completion of capital raising
activities, and those that are not primarily financial in nature such as the
launching of technology or the hiring of key employees. If it is determined that
an impairment has occurred with respect to an investment in a portfolio company,
in the absence of quantitative valuation metrics, management estimates the
impairment and/or the net realizable value of the portfolio investment based on
public- and private-company market comparable information and valuations
completed for companies similar to our portfolio companies. Future adverse
changes in market conditions, poor operating results of underlying investments
and other information obtained after our quarterly assessment could result in
losses or an inability to recover the current carrying value of the investments
thereby possibly requiring an impairment charge in the future. Based on these
measurements, an impairment loss of $3.5 million was recorded during the current
quarter.
VALUATION OF INTANGIBLE ASSETS. Intangible assets, net of accumulated
amortization, totaled $27.0 million as of April 30, 2002. We periodically
evaluate our intangible assets for indications of impairment whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Intangible assets include goodwill, purchased technology and
capitalized software. Factors we consider important which could trigger an
impairment review include significant under-performance relative to expected
historical or projected future operating results, significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business or significant negative industry or economic trends. If this evaluation
indicates that the value of the intangible asset may be impaired, an evaluation
of the recoverability of the net carrying value of the asset over its remaining
useful life is made. If this evaluation indicates that the intangible asset is
not recoverable, based on the estimated undiscounted future cash flows of the
entity or technology acquired over the remaining amortization period, the net
carrying value of the related intangible asset will be reduced to fair value and
the remaining amortization period may be adjusted. Any such impairment charge
could be significant and could have a material adverse effect on our reported
financial statements if and when an impairment charge is recorded. If an
impairment charge is recognized, the amortization related to goodwill and other
intangible assets would decrease during the remainder of the fiscal year. No
impairment losses were recorded during the current quarter based on these
measurements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. As of April 30, 2002, the allowance for
doubtful accounts totaled $10.9 million. Management estimates the collectibility
of our accounts receivable on an account-by-account basis. We record an increase
in the allowance for doubtful accounts when the prospect of collecting a
specific account receivable becomes doubtful. In addition, we provide for a
general reserve on all accounts receivable, using a specified percentage of the
outstanding balance in each aged group. Management specifically analyzes
accounts receivable and historical bad debt experience, customer
creditworthiness, current economic trends, international exposures (such as
currency devaluation), and changes in our customer payment terms when evaluating
the adequacy of the allowance for doubtful accounts. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
INCOME TAXES. Our effective tax rate is directly affected by the relative
proportions of domestic and international revenue and income before taxes. We
are also subject to changing tax laws in the multiple jurisdictions in which we
operate. As of April 30, 2002, net deferred tax assets totaled $174.1 million.
We believe that it is more likely than not that the results of future operations
will generate sufficient taxable income to utilize these net deferred tax
assets. While we have considered future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for any valuation
allowance, should we determine that we would not be able to realize all or part
of our net deferred tax asset in the future, an adjustment to the deferred tax
asset would be charged to income in the period such determination was made.
15
RESULTS OF OPERATIONS
REVENUE. Revenue consists of fees for perpetual and ratable licenses of our
software products, sales of hardware system products, post-contract customer
support (PCS), customer training and consulting. We classify revenues as
product, service or ratable license. Product revenue consists primarily of
perpetual license product revenue. Service revenue consists of PCS under
perpetual licenses and fees for consulting services and training. Ratable
license revenue consists of all revenue from our technology subscription
licenses (TSLs) and from time-based licenses sold prior to the adoption of TSLs
in August 2000 that include extended payment terms or unspecified additional
products.
TSLs are time-limited rights to use our software. Since TSLs include bundled
product and services, both product and service revenue is generally recognized
ratably over the term of the license, or, if later, as payments become due. The
terms of TSLs, and the payments due thereon, may be structured flexibly to meet
the needs of the customer. With minor exceptions, under TSLs, customers cannot
obtain major new products developed or acquired during the term of their license
without making an additional purchase.
We introduced TSLs in the fourth quarter of fiscal 2000. The replacement of
the prior form of time-based licenses by TSLs has impacted and will continue to
impact our reported revenue. When a customer buys a TSL, relatively little
revenue is recognized during the quarter the product is initially delivered. The
remaining amount will be either recorded as deferred revenue on our balance
sheet or considered backlog by the Company and not recorded on the balance
sheet. The amount recorded as deferred revenue is equal to the portion of the
license fee that has been invoiced or paid but not recognized. This amount moves
out of backlog and is recorded as deferred revenue as invoiced or as additional
payments are made. Under the prior form of time-based licenses, a high
proportion of all license revenue was recognized in the quarter that the product
was delivered, with relatively little recorded as deferred revenue or as
backlog. Therefore, an order for a TSL will result in significantly lower
current-period revenue than an equal-sized order under the prior form of
time-based licenses.
Since our introduction of TSLs the average TSL duration has been
approximately 3.25 years. This means that on a standalone basis the transition
of our license base to TSLs will continue to impact our reported revenue until
at least the first quarter of fiscal year 2004. This transition period will be
extended as a result of our merger with Avant!. Avant!'s historical license mix
has a higher proportion of perpetual licenses and a lower proportion of ratable
licenses than ours. We expect that the license mix of the combined company will
be closer to Synopsys' than Avant!'s. We anticipate that this transition will
reduce reported revenue by approximately $50 million for the remainder of fiscal
year 2002. Our initial estimate of the impact for fiscal year 2003 is that the
transition will reduce reported revenue by approximately $60 million.
We set revenue targets for any given quarter based, in part, upon an
assumption that we will achieve a certain license mix of perpetual licenses and
TSLs. The actual mix of licenses sold affects the revenue we recognize in the
period. If we are unable to achieve our target license mix, we may not meet our
revenue targets. Our target license mix for total new software license orders
for the remainder of fiscal year 2002 is 25% to 30% perpetual licenses and 70%
to 75% ratable licenses. For fiscal year 2003 out target license mix for total
new software license orders is 22% to 27% perpetual licenses and 73% to 78%
ratable licenses. In the second quarter of fiscal 2002, the license mix was
approximately 21% perpetual licenses and 79% TSLs, in comparison to 23%
perpetual licenses and 77% TSLs in the second quarter of fiscal 2001.
As expected, total revenue for the second quarter of fiscal 2002 increased
14% to $185.6 million as compared to $163.5 million for the second quarter of
fiscal 2001. Revenue for the six months ended April 30, 2002 increased 13% to
$361.2 million compared to $320.7 million for the six months ended April 30,
2001. The increase in total revenue for the three- and six months ended April
30, 2002 compared to the same periods in 2001 is due primarily to increased
product orders and to the additional quarters that the TSL license model has
been used and the related increase in revenue due to the timing of revenue
recognition under this license model.
16
Product revenue increased 58% to $52.3 million for the second quarter of
fiscal 2002, compared to $33.1 million for the second quarter of fiscal 2001 and
27% to $91.8 million for the six months ended April 30, 2002 compared to $72.3
million for the same period in fiscal 2001. The increase in product revenue is
directly related to the increase in orders for perpetual licenses during the
periods, since, in most cases, product revenue is recognized in the same quarter
that an order for a perpetual license is received. During the second quarter, we
began offering variable maintenance arrangements to certain customers that
entered into perpetual license technology in excess of $2.0 million. Under these
arrangements, the annual fee for PCS is calculated as a percentage of the net
license fee rather than a fixed percentage of the list price.
Service revenue was $65.8 million and $91.5 million for the second quarters
of 2002 and 2001, respectively, and $134.9 million and $178.5 million for the
six-month periods ended April 30, 2002 and 2001, respectively. The 24% decrease
in service revenue in 2002 is due, in part, to economic factors and to a
decrease in maintenance renewals. Since the middle of 2001, customers have
reduced their use of outside consultants as part of their overall cost-cutting
efforts. As a result, we received a lower volume of new consulting orders than
expected, which has reduced the backlog of projects available to produce
revenue. In addition, customers have deferred delivery dates (and thus payments)
on certain existing projects and having cancelled others. Training revenue has
been reduced by our customers' efforts to curtail training and travel expenses.
Service revenue attributable to maintenance was lower than expected because a
number of customers have failed to renew their annual PCS contracts on their
installed base of perpetual licenses. In addition, service revenue attributable
to maintenance is also impacted by three trends. First, new licenses structured
as TSLs include bundled PCS. Second, customers with existing perpetual licenses
are entering into new TSLs rather than renewing the PCS on the existing
perpetual licenses. Third, customers with existing perpetual licenses are
converting their existing perpetual licenses to TSLs. In each case, revenue
attributable to PCS that otherwise would have been reflected in service revenue
is not reflected in ratable license revenue.
REVENUE EXPECTATIONS. For the full fiscal year 2003, we expect revenue to
consist of 15% to 20% product revenue, 50% to 55% TSLs and 30% to 35% services
revenue, including the impact of the acquisition with Avant!.
INTERNATIONAL REVENUE. The following table summarizes the performance of
the various regions as a percent of total Company revenue:
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------- ------------- ------------
North America 69% 62% 65% 61%
Europe 16% 18% 18% 18%
Japan 9% 11% 9% 11%
Other 6% 9% 8% 10%
------------ ------------- ------------- ------------
Total 100% 100% 100% 100%
============ ============= ============= ============
International revenue as a percentage of total revenue for the quarter ended
April 30, 2002 decreased to 31% from 38% for the quarter ended April 30, 2001
and to 35% from 39% for the six-month periods ended April 30, 2002 and 2001,
respectively. In any given period, the geographic mix of revenue is influenced
by the particular contracts closed during the quarter. International sales are
vulnerable to regional or worldwide economic or political conditions. In
particular, a number of our largest European customers are in the
telecommunications equipment business, which has weakened considerably. The
majority of our international sales are denominated in the U.S. dollar. There
were no foreign exchange gains or losses that were material to our financial
results during the three- and six-month periods ended April 30, 2002 and 2001.
17
REVENUE - PRODUCT GROUPS. For management reporting purposes, our products
have been organized into four distinct product groups -- IC Implementation,
Verification and Test, Intellectual Property and System Level Design, Transistor
Level Design -- and a services group -- Professional Services. The following
table summarizes the revenue attributable to the various groups as a percentage
of total Company revenue for the last seven quarters:
Q2-2002 Q1-2002 Q4-2001 Q3-2001 Q2-2001 Q1-2001 Q4-2000
--------- --------- --------- --------- --------- --------- --------
Revenue
IC Implementation
DC Family 31% 32% 32% 32% 33% 34% 33%
Physical Synthesis 11 9 11 7 6 4 6
--------- ---------- -------- --------- --------- --------- --------
42 41 43 39 39 38 39
Verification and Test 31 32 30 30 28 28 26
IP and System Level Design 11 11 12 13 12 12 14
Transistor Level Design 8 8 6 8 7 9 7
Professional Services 8 8 9 10 14 13 14
--------- --------- --------- --------- --------- -------- ---------
Total Company 100% 100% 100% 100% 100% 100% 100%
========= ========= ========= ========= ========= ======== =========
IC IMPLEMENTATION. IC implementation includes two product categories, the
Design Compiler (DC) Family and Physical Synthesis and, as a percent of revenue,
has increased from 39% to 42% over the last seven quarters. Over the same
period, the DC Family, including Design Compiler and all ancillary and related
logic design products, as a percentage of total revenue, has decreased from 33%
to 31% and Physical Synthesis products have increased from 6% to 11% of total
revenues.
Included in the Physical Synthesis family are Physical Compiler, a product
that unifies synthesis, placement and global routing, Chip Architect, a chip
floor-planning product, Flex Route, a top level router and our recently
introduced products - ClockTree Compiler, a clock tree synthesis product, and
Route Compiler, a standard cell router integrated into Physical Compiler that
completes detailed routing.
VERIFICATION AND TEST. Verification and Test includes our simulation, timing
analysis, formal verification and test products. As a percent of revenue,
revenue from this product family has increased from 26% to 31% since the
introduction of our ratable license model. This increase in revenue as a percent
of total revenue is primarily due to increased subscription revenue for
PrimeTime as a result of the quarterly amortization of deferred revenue which is
an inherent result of the use of the ratable license model.
INTELLECTUAL PROPERTY AND SYSTEM LEVEL DESIGN (IP&S). Our IP&S products
include the DesignWare library of design components and verification models, and
system design products. Revenue as a percent of total revenue decreased from the
fourth quarter of fiscal 2000 to the first quarter of fiscal 2001. Revenue has
remained relatively flat over the last six quarters, ranging from 11% to 14% due
in part to the fact that the term of many of these licenses has increased from
one to three years.
TRANSISTOR LEVEL DESIGN. Our transistor level design product group includes
tools that are used in transistor level simulation and analysis. Revenue from
this product group as a percentage of total revenues have fluctuated from 6% to
9% since the introduction of TSLs as a result of the mix of license types for
orders received during a particular quarter.
PROFESSIONAL SERVICES. The Professional Services group includes consulting
and training activities. This group provides consulting services, including
design methodology assistance, specialized telecommunications systems design
services and turnkey design. Revenue from professional services as a percentage
of total revenues has declined from 14% in the fourth quarter of fiscal 2000 to
8% in the first quarter of fiscal 2002, reflecting, as described above under
"Revenue" the impact of the economic environment.
COST OF REVENUE. Cost of revenue consists of the cost of product revenue,
cost of service revenue and cost of ratable license revenue. Cost of product
revenue includes personnel and related costs, production costs, product
packaging, documentation, amortization of capitalized software development costs
and purchased technology, and costs of the components of our hardware system
products. The cost of internally developed capitalized software is amortized
based on the greater of the ratio of current product revenue to the total of
current and anticipated product revenue or the straight-line method over the
software's estimated economic life of approximately two years. Cost of service
revenue includes consulting services, personnel and related costs associated
with providing training and PCS on perpetual licenses. Cost of ratable license
revenue includes the costs of product and services related to our TSLs, since
TSLs include bundled product and services. Cost of ratable license revenue, cost
of product revenue and cost of service revenue is heavily dependent on an
absolute basis on the mix of software orders received during the period.
18
Cost of product revenue decreased to 6% of total product revenue for the
three months ended April 30, 2002, as compared to 15% for the same period during
2001. Cost of product revenue was 8% and 13% for the six months ended April 30,
2002 and 2001, respectively. This decrease in cost of product revenue as a
percentage of total product revenue for the three- and six-month periods ended
April 30, 2002 as compared to 2001 is due in part to the wind-down of our
internet business unit during the third quarter of fiscal 2001 and in part to
the mix of software orders received during the periods.
Cost of service revenue as a percentage of total service revenue was 26% and
22% for the second quarters of fiscal 2002 and 2001, respectively and increased
to 28% from 22% for the six months ended April 30, 2002 and 2001, respectively.
The increase in cost of service revenue as a percentage of total service revenue
is due primarily to the decline in total service revenue and to decreased
utilization of our professional services personnel, both as a result of the
economic environment.
Cost of ratable license revenue was 20% in the second quarter of fiscal 2002
compared to 16% for the second quarter of 2001 and was 18% and 19% for the six
months ended April 30, 2002 and 2001, respectively. The cost of ratable license
revenue as a percent of the related revenue is impacted by the mix of orders
between product, service and ratable revenue during the particular quarter.
COST REDUCTION PROGRAM. During the first quarter of fiscal 2002, the Company
implemented a cost reduction program which included a workforce reduction in
March 2002. The purpose was to reduce expenses by decreasing the number of
employees in all departments, both domestically and internationally. As a
result, the Company's workforce was decreased by approximately 175 employees and
a charge of approximately $3.9 million is included in operating expenses during
the second quarter of fiscal 2002. This charge consists of severance and other
special termination benefits.
RESEARCH AND DEVELOPMENT. Research and development expenses remained
relatively flat at $46.6 million compared to $47.6 million for the second
quarter of fiscal 2001. Research and development expenses represented 25% and
29% of total revenue in the second fiscal quarter of 2002 and 2001,
respectively. The decrease in terms of dollars is due to a decrease of $1.0
million in consulting and contractor costs and $0.8 million related to our
workforce reduction program. These decreases are offset by an increase in
compensation and compensation-related costs of $0.4 million related to higher
levels of research and development staffing compared to the prior year and an
increase in depreciation expense of $0.7 million.
Research and development expenses were $95.4 million for the six-month
period ended April 30, 2002 and $93.9 million for the six-month period ended
April 30, 2001. As a percentage of total revenue, research and development
expenses represented 26% and 29% for the six-month periods ended April 30, 2002
and 2001, respectively. The increase in terms of dollars is due to the increase
in compensation and compensation-related costs of $5.2 million related to higher
levels of research and development staffing and annual merit and cost of living
increases, which were implemented in the second quarter of 2001. These increases
are offset by lower employee benefit costs related to a change in our health and
welfare benefit programs. Depreciation expense also increased $1.2 million.
Expenses related to consultants and other expenses, including facilities,
travel, communications, supplies and recruiting, decreased $2.5 million and $2.2
million, respectively, as a result of our cost reduction programs.
SALES AND MARKETING. Sales and marketing expenses decreased by 9% to $63.2
million in the second quarter of fiscal 2002 from $69.2 million in the same
quarter last year. Sales and marketing expenses represented 34% and 42% of total
revenue in the second fiscal quarter of 2002 and 2001, respectively. The
decrease in the three-month period in fiscal 2002 in comparison to fiscal 2001
in terms of dollars resulted in part from a decrease in compensation and
compensation-related costs of $1.4 million due to a decline in sales commissions
as well as a decrease in the cost of benefits related to a change in our health
and welfare benefit programs. These decreases were offset in part by annual
merit and cost of living increases, which were implemented in the second quarter
of 2001. Employee functions, consulting expenses and other expenses, including
facilities, travel and information technology also decreased $0.5 million, $1.4
million and $2.6 million as a result of the Company's cost reduction efforts.
Sales and marketing expenses were $123.0 million and $138.8 million (34% and
43% of total revenue) for the six-month periods ended April 30, 2002 and 2001,
respectively. The decrease in the six-month period in fiscal 2002 in comparison
to fiscal 2001 period in terms of dollars resulted in part from a decrease in
compensation and compensation-related costs of $7.7 million due to a decline in
sales commissions as well as a decrease in the cost of benefits related to a
change in our health and welfare benefit programs. These decreases were offset
by annual merit and cost of living increases, which were implemented in the
second quarter of 2001. Employee functions, consulting expenses and other
expenses including facilities, travel and information technology also decreased
$1.8 million, $2.4 million and $3.9 million as a result of the Company's cost
reduction efforts.
19
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
16% to $17.5 million in the second quarter of fiscal 2002, compared to $15.1
million in the same quarter last year. General and administrative expenses
represented 9% of total revenue for both the three-month periods ended April 30,
2002 and 2001, respectively. This increase is due in part to an increase in
litigation expenses relating to certain legal actions initiated by Synopsys.
Equipment and maintenance expense also increased $2.0 million due to new
maintenance contracts associated with the upgrade of our infrastructure systems.
Further, there were increases in bad debt expense and depreciation expense of
$0.5 million and $0.7 million. These increases were offset by a decrease in
compensation and compensation-related costs of $0.7 million as a result of the
Company's cost reduction efforts.
General and administrative expenses increased 14% to $36.2 million from
$31.8 million for the six months ended April 30, 2002 and 2001, respectively.
General and administrative expenses represented 10% of total revenue for both
the six-month periods ended April 30, 2002 and 2001. This increase is due in
part to an increase in litigation expenses relating to certain legal actions
initiated by Synopsys. Equipment and maintenance expense also increased in
comparison to the prior year by approximately $6.4 million due primarily to new
maintenance contracts associated with the upgrade of our infrastructure systems.
Further, there was an increase in bad debt expense of approximately $0.6
million. These increases were offset by decreases in compensation and
compensation-related costs as a result of the reorganization of certain human
resource functions which occurred during the first quarter of fiscal 2002 and
the Company's cost reduction efforts.
AMORTIZATION OF INTANGIBLE ASSETS. Goodwill represents the excess of the
aggregate purchase price over the fair value of the tangible and identifiable
intangible assets we have acquired. Intangible assets and goodwill are amortized
over their estimated useful life of three to five years. We assess the
recoverability of goodwill by estimating whether the unamortized cost will be
recovered through estimated future undiscounted cash flows. Amortization of
intangible assets charged to operations in the second quarter of fiscal 2002 was
$4.4 million compared to $4.2 million for the same period last year.
Amortization of intangible assets charged to operations was $8.4 million and
$8.4 million for the six months ended April 30, 2002 and 2001, respectively. The
Financial Accounting Standards Board recently issued new guidance with respect
to the amortization and evaluation of goodwill. This new guidance is discussed
below under Effect of New Accounting Standards.
OTHER INCOME, NET. Other income, net was $11.2 million in the second quarter
of fiscal 2002, as compared to $21.9 million in the same quarter in the prior
year. This decrease is due in part to the gains recognized on the sale of
securities during the second quarter of fiscal 2002 of $6.8 million, compared to
$15.3 million for the same period during 2001. Interest income for the second
quarter of 2002 was $2.3 million compared to $3.6 million for the second quarter
of 2001. Although cash balances were higher as of April 30, 2002 than a year
ago, significantly lower interest rates the Company's shift of its investments
into shorter maturity instruments in anticipation of the Avant! merger resulted
in a decrease in interest income. The second quarters of 2002 and 2001 include
investment impairment charges of approximately $3.5 million and $1.0 million,
respectively, to write down the carrying value of certain assets held in our
venture fund to the best estimate of net realizable value. The second quarter of
fiscal 2002 also includes a net gain of $3.1 million related to the termination
fee for the IKOS agreement net of costs incurred. The remaining changes to other
income, net relate to rental income, the amortization of premium on equity
forwards and foreign exchange gains and losses recognized during the quarter.
Other income, net was $22.3 million and $47.4 million for the six months
ended April 30, 2002 and 2001, respectively. The six-month decrease is due in
part to the gain of $10.6 million on the sale of our silicon libraries business
to Artisan during 2001 and in part to realized gains on investments, which were
$12.4 million for fiscal 2002 as compared to $29.6 million for fiscal 2001.
These gains were partially offset by the write-down of certain assets in our
venture portfolio in the amount of $3.5 million and $4.3 million for the six
months of fiscal 2002 and 2001, respectively. Interest income in the six months
ended April 30, 2002 was $4.5 million million, as compared to $7.8 million in
the same quarter last year. Although cash balances were higher as of April 30,
2002 than a year ago, a significantly lower interest rate environment and a
shortened average investment maturity in anticipation of the Avant! acquisition
resulted in a decrease in interest income. The second quarter of fiscal 2002
also includes a net gain of $3.1 million related to the termination fee for the
IKOS agreement net of costs incurred. Further, rental income was $4.8 million
and $3.7 for the six-month periods ended April 30, 2002 and 2001, respectively.
The remaining changes to other income, net relate to the amortization of premium
forwards and foreign exchange gains and losses recognized during the quarter.
During the six months ended April 30, 2002 and 2001, we determined that
certain of the assets held in our venture fund valued at $4.0 million and $7.8
million, respectively, were impaired and that the impairment was other than
temporary. Accordingly, we recorded charges of approximately $3.5 million and
$4.3 million for the six months ended April 30, 2002 and 2001, respectively, to
write down the carrying value of the investments to the best estimate of net
realizable value. Impairment charges relate to certain investments in non-public
companies and represent management's estimate of the impairment incurred during
the period as a result of specific analysis of each investment, considering the
activities of and events occurring at each of the underlying portfolio companies
during the quarter.
20
Our portfolio companies operate in industries that are rapidly evolving and
extremely competitive. For equity investments in non-public companies for which
there is not a market in which their value is readily determinable, we assess
each investment for indicators of impairment at each quarter-end based primarily
on achievement of business plan objectives and current market conditions, among
other factors, and information available to us at the time of this quarterly
assessment. The primary business plan objectives we consider include, among
others, those related to financial performance such as achievement of planned
financial results or completion of capital raising activities, and those that
are not primarily financial in nature such as the launching of technology or the
hiring of key employees. If it is determined that an impairment has occurred
with respect to an investment in a portfolio company, in the absence of
quantitative valuation metrics, management estimates the impairment and/or the
net realizable value of the portfolio investment based on public- and
private-company market comparable information and valuations completed for
companies similar to our portfolio companies.
INTEREST RATE RISK. Our exposure to market risk for a change in interest
rates relates to our investment portfolio. We place our investments in a mix of
short-term tax exempt and taxable instruments that meet high credit quality
standards, as specified in our investment policy. This policy also limits the
amount of credit exposure to any one issue, issuer and type of instrument. We do
not anticipate any material losses with respect to our short-term investment
portfolio.
The following table presents the carrying value and related weighted-average
interest return for our investment portfolio. The carrying value approximates
fair value at April 30, 2002. In accordance with our investment policy, the
weighted-average duration of our invested funds portfolio does not exceed one
year.
Principal (Notional) Amounts in U.S. Dollars:
WEIGHTED-AVERAGE
CARRYING AFTER TAX
(IN THOUSANDS, EXCEPT INTEREST RATES) AMOUNT INTEREST RETURN
------------- ------------------
Short-term investments - fixed rate 48,170 2.26%
Money market funds - variable rate 436,256 1.36%
-------------
Total interest bearing instruments $ 484,426 1.45%
=============
FOREIGN CURRENCY RISK. At the present time, we do not generally hedge
anticipated foreign currency cash flows but hedge only those currency exposures
associated with certain assets and liabilities denominated in nonfunctional
currencies. Hedging activities undertaken are intended to offset the impact of
currency fluctuations on these balances. The success of this activity depends
upon the accuracy of our estimates of balances denominated in various
currencies, primarily the Euro, Japanese yen, Taiwan dollar, British pound
sterling, Canadian dollar, and Singapore dollar. We had contracts for the sale
and purchase of foreign currencies with a notional value expressed in U.S.
dollars of $110.1 million as of April 30, 2002. Looking forward, we do not
anticipate any material adverse effect on our consolidated financial position,
results of operations, or cash flows resulting from the use of these
instruments. There can be no assurance that these hedging transactions will be
effective in the future.
The following table provides information about our foreign exchange forward
contracts at April 30, 2002. Due to the short-term nature of these contracts,
the contract rate approximates the weighted-average contractual foreign currency
exchange rate at April 30, 2002. These forward contracts mature in approximately
thirty days.
Short-Term Forward Contracts to Sell and Buy Foreign Currencies in U.S.
Dollars:
USD AMOUNT CONTRACT RATE
---------------- -----------------
(IN THOUSANDS, EXCEPT FOR CONTRACT RATES)
Forward Net Contract Values:
Euro $ 83,734 1.1112
Japanese yen 15,274 128.79
Taiwan dollar 987 34.665
British pound sterling 2,921 0.6872
Canadian dollar 4,557 1.5683
Singapore dollar 2,587 1.8110
----------------
$ 110,060
================
The unrealized gains/losses on the outstanding forward contracts at April
30, 2002 were immaterial to our consolidated financial statements. The realized
gain/losses on these contracts as they matured were not material to our
consolidated financial position, results of operations or cash flows for the
periods presented.
21
We apply Statement of Financial Accounting Standards No. 133 (SFAS 133),
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended, in
accounting for our derivative financial instruments. SFAS 133 establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized as either
assets or liabilities at fair value. Derivatives that are not designated as
hedging instruments are adjusted to fair value through earnings. If the
derivative is designated as a hedging instrument, depending on the nature of the
exposure being hedged, changes in fair value will either be offset against the
change in fair value of the hedged asset, liability, or firm commitment through
earnings, or recognized in other comprehensive income until the hedged
anticipated transaction affects earnings. The ineffective portion of the hedge
is recognized in earnings immediately. We do not believe that ongoing
application of SFAS 133 will significantly alter our hedging strategies.
However, its application may increase the volatility of other income and expense
and other comprehensive income. Apart from our foreign currency hedging and
forward sales of certain equity investments, we do not use derivative financial
instruments. In particular, we do not use derivative financial instruments for
speculative or trading purposes.
TERMINATION OF AGREEMENT TO ACQUIRE IKOS SYSTEMS, INC. On July 2, 2001, we
entered into an Agreement and Plan of Merger and Reorganization (the "Merger
Agreement") with IKOS Systems, Inc. (IKOS). The Merger Agreement provided for
the acquisition of all outstanding shares of IKOS common stock by Synopsys.
On December 7, 2001, Mentor Graphics Corporation (Mentor) commenced a cash
tender offer to acquire all of the outstanding shares of IKOS common stock at
$11.00 per share, subject to certain conditions. On March 12, 2002, Synopsys and
IKOS executed a termination agreement by which the parties terminated the
Synopsys-IKOS merger agreement and pursuant to which IKOS paid Synopsys the $5.5
million termination fee required by the Synopsys-IKOS merger agreement. This
termination fee and $2.4 million of expenses incurred in conjunction with the
acquisition are included in other income, net on the unaudited condensed
consolidated statement of income. Synopsys subsequently executed a revised
termination agreement with Mentor and IKOS in order to add Mentor as a party
thereto.
ACQUISITION OF AVANT! CORPORATION. On June 6, 2002 (the "closing date"), we
completed the merger with Avant! Corporation (Avant!), a company which develops,
markets, licenses and supports electronic design automation software products
that assist design engineers in the physical layout, design, verification,
simulation, timing and analysis of advanced integrated circuits. Under the terms
of the merger agreement with Avant!, Avant! merged with and into a wholly owned
subsidiary of Synopsys. The merger will be accounted for under the purchase
method of accounting. The results of operations of Avant! are not included in
the accompanying condensed consolidated financial statements since the merger
occurred subsequent to the date of the our balance sheet.
REASONS FOR THE ACQUISITION. The Synopsys Board of Directors unanimously
approved the merger agreement at its December 1, 2001 meeting. In approving the
merger agreement and making these determinations and recommendations, the Board
of Directors consulted with legal and financial advisors as well as with
management and considered a number of factors. These factors include the fact
that the merger would enable Synopsys and Avant! to offer their semiconductor
customers a complete end-to-end solution for system-on-chip design that includes
Synopsys' logic synthesis and design verification tools with Avant!'s advanced
place and route, physical verification and design integrity products, thus
increasing customers' design efficiencies. By increasing customer design
efficiencies, Synopsys expects to be able to better compete for customers
designing the next generation of semiconductors. Further, by gaining access to
Avant!'s physical design and verification products, as well as its broad
customer base and relationships, Synopsys will gain new opportunities to market
its existing products. The foregoing discussion of the information and factors
considered by the Synopsys Board of Directors is not intended to be exhaustive
but includes the material factors considered by the Synopsys Board of Directors.
PURCHASE PRICE. Holders of Avant! common stock received 0.371 of a share of
Synopsys common stock (including the associated preferred stock rights) in
exchange for each share of Avant! common stock (the exchange ratio) owned as of
the closing date, aggregating approximately 14.5 million shares of Synopsys
common stock. The fair value of the Synopsys shares issued was based on a per
share value of $54.74, which is equal to Synopsys' average last sale price per
share as reported on the Nasdaq National Market for the trading-day period two
days before and after December 3, 2001, the date of the merger agreement.
The purchase consideration will include (a) the fair value of Synopsys
common stock issued of approximately $795.4 million, (b) the estimated fair
value of options to purchase Synopsys common stock to be issued, less the
portion of the intrinsic value of Avant!'s unvested options applicable to the
remaining vesting period, the determination of which amount is not complete as
of the date of this filing, (c) estimated merger related costs of approximately
$25 million, (d) employee severance costs, and (e) restructuring charges related
to exiting certain of Avant!'s activities, including certain facilities, and
workforce reductions, in accordance with Emerging Issues Task Force (EITF) Issue
No. 95-3.
22
The estimated merger-related costs consist primarily of banking, legal and
accounting fees, printing costs, and other directly related charges.
Employee severance costs consist of a cash severance payment due upon the
closing of the merger of $41.8 million to Avant!'s Chairman of the Board and
cash severance payments to other employees of Avant!, the determination of which
amount is not complete as of the date of this filing.
As of the date of filing this Form 10-Q, the valuation of Avant!'s assets
and liabilities, including identifiable intangible assets, as of the closing
date has not been completed. Furthermore, completion of integration planning
will result in additional accruals for severance costs and/or facilities
closures. Such accruals will increase the purchase consideration and the
allocation of the purchase consideration to goodwill. Due to acceleration
provisions related to certain of Avant!'s stock options and the completion of
the integration planning, including workforce reductions, the estimated fair
value of options to purchase Synopsys common stock to be issued in the merger
has not been determined as of the date of this filing.
CADENCE LITIGATION. In connection with the merger, Synopsys has entered into
a policy with American International Group, Inc., a AAA rated insurance company,
whereby insurance has been obtained for certain compensatory, exemplary and
punitive damages, penalties and fines and attorneys' fees arising out of the
pending litigation between Avant! and Cadence Design Corporation, Inc. (the
"Avant!/Cadence litigation" or the "covered loss"). The Avant!/Cadence
litigation is described in the section entitled "Factors that may affect Future
Results". The policy does not provide coverage for litigation other than the
Avant!/Cadence litigation.
In return for a premium of $335 million, the insurer will be obligated to
pay covered loss up to a limit of liability equaling (a) $500 million plus (b)
interest accruing at the fixed rate of 2%, compounded semi-annually, on $250
million (the "interest component"), as reduced by previous covered losses. The
policy will expire following a final judgment or settlement of the
Avant!/Cadence litigation or any earlier date upon Synopsys' election. Upon such
expiration, Synopsys will be entitled to a payment equal to $240 million plus
the interest component less any covered loss paid under the policy (which, for
this purpose, shall include legal fees only to the extent that the aggregate
amount of such fees exceeds $10 million).
The contingently refundable portion of the insurance premium ($240 million)
will be included in the post-merger balance sheet as a long-term restricted
asset. Interest earned on that amount will be included in other income, net in
the post-merger statement of operations. The balance of the premium paid to the
insurer ($95 million) will be recognized as expense in the third quarter of
fiscal 2002.
At the closing date, the Cadence/Avant! litigation has been accounted for as
a pre-merger contingency because a litigation judgment or settlement amount, if
any, is not probable or estimable. If a litigation loss becomes probable and
estimable after the date of the merger, such loss will be included in net
income.
GOODWILL AND INTANGIBLE ASSETS. Goodwill, representing the excess of the
purchase price over the fair value of tangible and identifiable intangible
assets, acquired in the merger will not be amortized, consistent with the
guidance with SFAS 142. Upon completion of the valuation of Avant!'s assets and
liabilities, including identifiable intangible assets, any resulting allocation
to acquired in-process technology will be reflected in the post-merger statement
of income. In addition, a portion of the purchase price will be allocated to
identifiable intangible assets, including the following:
Intangible Asset Estimated Useful Life
- ----------------------------------------- --------------------------------------
Core/developed technology 3 years
Contract right intangible 3 years
Customer installed base/relationship 6 years
Trademarks and tradenames 3 years
Covenants not to compete The life of the related agreement
(2 to 4 years)
EFFECT OF NEW ACCOUNTING STANDARDS. In July 2001, the Financial Accounting
Standards Board issued Statements of Financial Accounting Standards No. 141,
BUSINESS COMBINATIONS, (SFAS 141) and No. 142, GOODWILL AND OTHER INTANGIBLE
ASSETS (SFAS 142). SFAS 141 requires that the purchase method of accounting be
used for all business combinations initiated after June 30, 2001 and specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized apart from goodwill. SFAS 142 requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually in accordance with the
provisions of SFAS 142.
23
We adopted the provisions of SFAS 141 on July 1, 2001. Under SFAS 141,
goodwill and intangible assets with indefinite useful lives acquired in a
purchase business combination completed after June 30, 2001, but before SFAS 142
is adopted, will not be amortized but will continue to be evaluated for
impairment in accordance with SFAS 121. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized and tested for impairment in accordance with current accounting
guidance until the date of adoption of SFAS 142.
Upon adoption of SFAS 142, we must evaluate its existing intangible assets
and goodwill acquired in purchase business combinations prior to July 1, 2001,
and make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, we will be required to reassess the useful lives and residual values of all
intangible assets acquired, and make any necessary amortization period
adjustments. We will also be required to test goodwill for impairment in
accordance with the provisions of SFAS 142 within the six-month period following
adoption. Any impairment loss will be measured as of the date of adoption and
recognized immediately as the cumulative effect of a change in accounting
principle. Any subsequent impairment losses will be included in operating
activities.
We expect to adopt SFAS 142 on November 1, 2002. As of April 30, 2002,
unamortized goodwill is $27.0 million, which, in accordance with the Statements,
will continue to be amortized until the date of adoption of SFAS 142.
Amortization of goodwill for the three- and six-month periods ended April 30,
2002 was $3.9 million and $7.9 million, respectively. The Company does not have
any intangible assets with an indefinite useful life. Because of the extensive
effort needed to comply with adopting SFAS 142, it is not practicable to
reasonably estimate the impact of adopting this Statement on our financial
statements at the date of this report, including whether we will be required to
recognize any transitional impairment losses.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS (SFAS 143). SFAS 143 requires that asset retirement obligations that
are identifiable upon acquisition, construction or development and during the
operating life of a long-lived asset be recorded as a liability using the
present value of the estimated cash flows. A corresponding amount would be
capitalized as part of the asset's carrying amount and amortized to expense over
the asset's useful life. The Company is required to adopt the provisions of SFAS
143 effective November 1, 2002. The Company is currently evaluating the impact
of adoption of this Statement on its financial position and results of
operations.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS (SFAS 144), which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED OF, and the accounting and reporting provisions
of APB Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS FOR A DISPOSAL OF A
SEGMENT OF A BUSINESS. The Company is required to adopt the provisions of SFAS
144 no later than November 1, 2002. The Company does not expect that the
adoption of SFAS 144 will have a significant impact on its financial position
and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments were $531.7 million at
April 30, 2002, an increase of $55.3 million, or 12%, from October 31, 2001.
Cash used in operating activities was $11.1 million for the six months ended
April 30, 2002 compared to $96.9 million provided by operating activities for
the same period in the prior year. The decrease in cash flows from operating
activities is due primarily to payments for income taxes and other liabilities
made during the first quarter as well as a decrease in the deferred revenue
liability.
Cash provided by investing activities was $144.6 million in the first six
months of 2002 compared to $44.5 million provided by investing activities during
same period in 2001. The increase in cash provided by investing activities of
$100.1 million is primarily due to net proceeds from the sale of short- and
long-term investments totaling $172.0 million for the six months ended April 30,
2002 as compared to net proceeds of investments totaling $74.7 million for the
same period during 2001. Capital expenditures totaled $26.5 million in the first
six months of fiscal 2002 as we continue to invest in fixed assets, primarily
related to construction of our Oregon facilities and computing equipment to
upgrade our infrastructure systems. In addition, cash proceeds from the sale of
our silicon libraries business were $4.1 million in the first quarter of fiscal
2001.
Cash provided by financing activities was $77.8 million for the six months
ended April 30, 2002 compared to $146.1 million used in financing activities
during the same period during fiscal 2001. Financing proceeds from the exercise
of stock options during the six months ended April 30, 2002 and 2001 were $65.3
million.
24
The primary financing uses of cash during the six months ended April 30, 2001
were for the purchase of treasury stock, net of reissuances and payment of
obligations totaling $206.3 million and $5.1 million, respectively. During the
six months ended April 30, 2002, we issued $11.1 million in shares of treasury
stock under our Employee Stock Purchase Program. We did not purchase any
treasury stock during the first two quarters of fiscal 2002. However, we may
resume the program in the third quarter of fiscal 2002.
Accounts receivable increased to $152.0 million at April 30, 2002 compared
to $146.3 million at October 31, 2001. Days sales outstanding, which is
calculated based on revenues for the most recent quarter and accounts receivable
as of the balance sheet date, increased to 74 days as of April 30, 2002 from 73
days at October 31, 2001 as a result of a decrease in revenues in the quarter
ended April 30, 2002 compared to the quarter ended October 31, 2001.
Our principle sources of cash are collections of accounts receivable and the
issuance of common stock. We believe that our current cash, cash equivalents,
short-term investments, lines of credit, and cash generated from operations will
satisfy our business requirements for at least the next twelve months.
As described above under "Acquisition of Avant! Corporation", in connection
with the Company's merger with Avant!, the Company has purchased an insurance
policy to protect it against losses resulting from the Avant!/Cadence
litigation. On June 7, 2002, the Company paid the premium for such policy, which
resulted in the transfer of $325 million to the insurance Company. As a result,
the Company's balance of cash and short-term investments at the end of the third
quarter of fiscal 2002 is expected to be substantially below the balance as of
the end of the second quarter. As described above, under certain circumstances,
at the end of the Avant!/Cadence litigation, the Company may be entitled to
receive back a portion of the amount paid to the insurer.
FACTORS THAT MAY AFFECT FUTURE RESULTS
WEAKNESS IN THE SEMICONDUCTOR AND ELECTRONICS BUSINESSES MAY NEGATIVELY
IMPACT SYNOPSYS' BUSINESS. Synopsys' business depends on the semiconductor and
electronics businesses. In 2001, these businesses experienced their sharpest
decline in orders and revenue in over 20 years and this weakness has continued
in 2002.
Purchases of our products are largely dependent upon the commencement of new
design projects by semiconductor manufacturers and their customers, the number
of design engineers and the increasing complexity of designs. During 2001 many
semi-conductor and electronic companies cancelled or deferred design projects
and reduced their design engineering staffs, which negatively impacted our
orders and revenues, particularly orders and revenues from our professional
services business. Demand for our products and services may also be affected by
partnerships and/or mergers in the semiconductor and systems industries, which
may reduce the aggregate level of purchases of our products and services by the
companies involved. Continuation or worsening of the current conditions in the
semiconductor industry, and continued consolidation among our customers, all
could have a material adverse effect on our business, financial condition and
results of operations.
SYNOPSYS' REVENUE AND EARNINGS MAY FLUCTUATE. Many factors affect our
revenue and earnings, which makes it difficult to achieve predictable revenue
and earnings growth. Among these factors are customer product and service
demand, product license terms, and the timing of revenue recognition on products
and services sold. The following specific factors could affect our revenue and
earnings in a particular quarter or over several quarterly or annual periods:
o Our products are complex, and before buying them customers spend a great
deal of time reviewing and testing them. Our customers' evaluation and
purchase cycles do not necessarily match our quarterly periods. In the
past, we have received a disproportionate volume of orders in the last week
of a quarter. In addition, a large proportion of our business is
attributable to our largest customers. As a result, if any order, and
especially a large order, is delayed beyond the end of a fiscal period, our
orders for that period could be below our plan and our revenue for that
period or future periods could be below any targets we may have published.
o Accounting rules determine when revenue is recognized on our orders, and
therefore impact how much revenue we will report in any given fiscal
period. The authoritative literature under which Synopsys recognizes
revenue has been, and is expected to continue to be, the subject of much
interpretative guidance. In general, after the adoption of TSLs in the
fourth quarter of fiscal 2000, most orders for our products and services
yield revenue over multiple quarters or years or upon completion of
performance rather than at the time the product is shipped. For any given
order, however, the specific terms agreed to with a customer may have the
effect of requiring deferral or acceleration of revenue in whole or in
part. Therefore, for any given fiscal period it is possible for us to fall
short in our revenue and/or earnings plan even while orders and backlog
remain on plan or, conversely, to meet or exceed our revenue and/or
earnings plan because of backlog and deferred revenue, while aggregate
orders are under plan.
25
o Our revenue and earnings targets are based, in part, upon an assumption
that we will achieve a license mix of perpetual licenses (on which revenue
is generally recognized in the quarter shipped) and TSLs (on which revenue
is recognized over the term of license) within a specified range, which is
adjusted from time to time. If we are unable to achieve a mix in this range
our ability to achieve short-term or long-term revenue and/or earnings
targets may be impaired.
SYNOPSYS MAY NOT BE ABLE TO SUCCESSFULLY COMPETE IN THE EDA INDUSTRY, WHICH
WOULD HAVE A MATERIAL ADVERSE EFFECT ON SYNOPSYS' RESULTS OF OPERATIONS. The EDA
industry is highly competitive. We compete against other EDA vendors, and with
customers' internally developed design tools and internal design capabilities
for a share of the overall EDA budgets of our potential customers. In general,
competition is based on product quality and features, post-sale support, price
and, as discussed below, the ability to offer a complete design flow. Our
competitors include companies that offer a broad range of products and services,
such as Cadence Design Systems, Inc. and Mentor Graphics Corporation, as well as
companies, including numerous recently public and start-up companies, that offer
products focused on a discrete phase of the integrated circuit design process.
In certain situations, Synopsys' competitors have been offering aggressive
discounts on certain of their products, in particular simulation and synthesis
products. As a result, average prices for these products may fall.
TECHNOLOGY ADVANCES AND CUSTOMER REQUIREMENTS CONTINUE TO FUEL A CHANGE IN
THE NATURE OF COMPETITION AMONG EDA VENDORS, WHICH COULD HURT SYNOPSYS' ABILITY
TO COMPETE. Increasingly, EDA companies compete on the basis of design flows
involving integrated logic and physical design products (referred to as physical
synthesis products) rather than on the basis of individual point tools
performing a discrete phase of the design process. The need to offer physical
synthesis products will become increasingly important as ICs grow more complex.
Our physical synthesis products compete principally with products from Cadence
and Magma Design Automation, both of which include more complete physical design
capabilities. We are working on completing our design flow. In June 2001, we
announced two physical design products, and in June 2002 we completed the Avant!
acquisition. However, there can be no guarantee that we will be able to offer a
competitive complete design flow to customers as a result of these efforts or
the Avant! acquisition. If we are unsuccessful in developing a complete design
flow on a timely basis or if we are unsuccessful in developing or convincing
customers to adopt our integrated design flow, our competitive position could be
significantly weakened.
SYNOPSYS' REVENUE GROWTH DEPENDS ON NEW AND NON-SYNTHESIS PRODUCTS, WHICH
MAY NOT BE ACCEPTED IN THE MARKETPLACE. Historically, much of our growth has
been attributable to the strength of our logic synthesis products. Our DC Family
of products accounted for 31% of revenue in the second quarter of fiscal 2002.
Over the long term, we expect the contribution from the DC Family to decline as
our customers transition from DC Family products to Physical Synthesis products.
In order to meet our revenue plan, aggregate revenues products other than the DC
family and from professional services must grow faster than our overall revenue
growth target. If such revenue growth fails to meet our goals, it will be
difficult for us to meet our overall revenue or earnings targets.
In order to sustain revenue growth over the long term, we will have to
enhance our existing products, introduce new products that are accepted by a
broad range of customers and to continue the growth in our consulting services
business. Product success is difficult to predict. The introduction of new
products and growth of a market for such products cannot be assured. In the past
we, like all companies, have introduced new products that have failed to meet
our revenue expectations. Expanding revenue from consulting services may be
difficult in the current economic environment. It will require us to continue to
develop effective management controls on bidding and executing on consulting
engagements. Increasing consulting orders and revenue while maintaining an
adequate level of profit can be difficult. There can be no assurance that we
will be successful in expanding revenue from existing or new products at the
desired rate or in expanding our services business, and the failure to do so
would have a material adverse effect on our business, financial condition and
results of operations.
BUSINESSES THAT SYNOPSYS HAS ACQUIRED OR THAT SYNOPSYS MAY ACQUIRE IN THE
FUTURE MAY NOT PERFORM AS PROJECTED. We have acquired or merged with a number of
companies in recent years, and as part of our efforts to increase revenue and
expand our product and services offerings we may acquire additional companies.
For example, in June 2002, Synopsys completed the Avant! merger. In addition to
direct costs, acquisitions pose a number of risks, including potential dilution
of earnings per share, problems in integrating the acquired products and
employees into our business, the failure to realize expected synergies or cost
savings, the failure of acquired products to achieve projected sales, the drain
on management time for acquisition-related activities, adverse effects on
customer buying patterns and assumption of unknown liabilities. While we attempt
to review proposed acquisitions carefully and negotiate terms that are favorable
to us, there is no assurance that any acquisition will have a positive effect on
our performance.
STAGNATION OF INTERNATIONAL ECONOMIES WOULD ADVERSELY AFFECT OUR
PERFORMANCE. During the three months ended April 30, 2002, 31% of our revenue
was derived from outside North America, as compared to 38% during the same
period in fiscal 2001. International sales are vulnerable to regional or
worldwide economic or political conditions and to changes in foreign currency
exchange rates.
26
Economic conditions in Europe, Japan and the rest of Asia have deteriorated in
recent quarters, and the longer this weakness persists the more likely it is to
have a negative impact on our business. In particular, a number of our largest
European customers are in the telecommunications equipment business, which has
weakened considerably. The Japanese economy has been stagnant for several years,
and may now be entering a recession. If the Japanese economy remains weak,
revenue and orders from Japan, and perhaps the rest of Asia, could be adversely
affected. In addition, the yen-dollar and Euro-dollar exchange rates remain
subject to unpredictable fluctuations. Weakness of the yen could adversely
affect revenue and orders from Japan during future quarters. Asian countries
other than Japan also have experienced economic and currency problems in recent
years, and in most cases they have not fully recovered. If such conditions
persist or worsen, orders and revenues from the Asia Pacific region would be
adversely affected.
A FAILURE TO RECRUIT AND RETAIN KEY EMPLOYEES WOULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR ABILITY TO COMPETE. Our success is dependent on technical and
other contributions of key employees. We participate in a dynamic industry, and
our headquarters is in Silicon Valley, where, despite recent economic
conditions, skilled technical, sales and management employees are in high
demand. There are a limited number of qualified EDA and IC design engineers, and
the competition for such individuals is intense. Despite economic conditions,
start-up activity in EDA remains significant, and a number of EDA companies have
gone public in the past year. Experience at Synopsys is highly valued in the EDA
industry and the general electronics industry, and our employees are recruited
aggressively by our competitors and by start-up companies in many industries. In
the past, we have experienced, and may continue to experience, significant
employee turnover. There can be no assurance that we can continue to recruit and
retain the technical and managerial personnel we need to run our business.
Failure to do so could have a material adverse effect on our business, financial
condition and results of operations.
A FAILURE TO PROTECT OUR PROPRIETARY TECHNOLOGY WOULD HAVE A MATERIAL
ADVERSE EFFECT ON SYNOPSYS' FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Our
success is dependent, in part, upon our proprietary technology and other
intellectual property rights. We rely on agreements with customers, employees
and others, and intellectual property laws, to protect our proprietary
technology. There can be no assurance that these agreements will not be
breached, that we would have adequate remedies for any breach or that our trade
secrets will not otherwise become known or be independently developed by
competitors. Moreover, effective intellectual property protection may be
unavailable or limited in certain foreign countries. Failure to obtain or
maintain appropriate patent, copyright or trade secret protection, for any
reason, could have a material adverse effect on our business, financial
condition and results of operations. In addition, there can be no assurance that
infringement claims will not be asserted against us and any such claims could
require us to enter into royalty arrangements or result in costly and
time-consuming litigation or could subject us to damages or injunctions
restricting our sale of products or could require us to redesign products.
OUR OPERATING EXPENSES DO NOT FLUCTUATE PROPORTIONATELY WITH FLUCTUATIONS IN
REVENUES, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS IN
THE EVENT OF A SHORTFALL IN REVENUE. Our operating expenses are based in part on
our expectations of future revenue, and expense levels are generally committed
in advance of revenue. Since only a small portion of our expenses varies with
revenue, a shortfall in revenue translates directly into a reduction in net
income. If we are unsuccessful in generating anticipated revenue or maintaining
expenses within this range, however, our business, financial condition and
results of operations could be materially adversely affected.
SYNOPSYS HAS ADOPTED ANTI-TAKEOVER PROVISIONS, WHICH MAY HAVE THE EFFECT OF
DELAYING OR PREVENTING CHANGES OF CONTROL OR MANAGEMENT. We have adopted a
number of provisions that could have anti-takeover effects. Our Board of
Directors has adopted a Preferred Shares Rights Plan, commonly referred to as a
poison pill. In addition, our Board of Directors has the authority, without
further action by its stockholders, to issue additional shares of Common Stock
and to fix the rights and preferences of, and to issue authorized but
undesignated shares of Preferred Stock. These and other provisions of Synopsys'
Restated Certificate of Incorporation and Bylaws and the Delaware General
Corporation Law may have the effect of deterring hostile takeovers or delaying
or preventing changes in control or management of Synopsys, including
transactions in which the stockholders of Synopsys might otherwise receive a
premium for their shares over then current market prices.
SYNOPSYS IS SUBJECT TO CHANGES IN FINANCIAL ACCOUNTING STANDARDS, WHICH MAY
AFFECT OUR REPORTED REVENUE, OR THE WAY WE CONDUCT BUSINESS. We prepare our
financial statements in conformity with accounting principles generally accepted
in the United States of America (GAAP). GAAP are subject to interpretation by
the Financial Accounting Standards Board, the American Institute of Certified
Public Accountants (AICPA), the SEC and various bodies appointed by these
organizations to interpret existing rules and create new accounting policies. In
particular, a task force of the Accounting Standards Executive Committee, a
subgroup of the AICPA, meets on a quarterly basis to review various issues
arising under the existing software revenue recognition rules, and
interpretations of these rules. Additional interpretations issued by the task
force may have an adverse effect on how we report revenue or on the way we
conduct our business in the future.
27
In addition, as a result of completing its merger with Avant!, Synopsys is
subject to additional risks and uncertainties, including the following:
o SYNOPSYS MAY FAIL TO INTEGRATE SUCCESSFULLY SYNOPSYS' AND AVANT!'S
OPERATIONS. AS A RESULT, SYNOPSYS MAY NOT ACHIEVE THE ANTICIPATED BENEFITS
OF THE ACQUISITION AND THE PRICE OF SYNOPSYS COMMON SHARES MIGHT BE
ADVERSELY AFFECTED. Synopsys acquired Avant! with the expectation that the
acquisition would result in benefits to Synopsys, including the offering of
a complete and, over time, integrated set of software products for the
design and verification of complex integrated circuits to its customers.
However, the expected benefits may not be fully realized. Achieving the
benefits of the acquisition will depend on many factors, including the
successful and timely integration of the products, technology and sales
operations of the two companies. These integration efforts may be difficult
and time consuming, especially considering the highly technical and complex
nature of each company's products. Failure to achieve a successful and
timely integration of their respective products and sales operations could
result in the loss of existing or potential customers of Synopsys and
Avant! and could have a material adverse effect on the business, financial
condition and results of operations of Synopsys and its subsidiaries,
including Avant!, and on the price of Synopsys common shares. Integration
efforts will also divert significant management attention and resources.
This diversion of attention and resources could have an adverse effect on
Synopsys during such transition period.
o SYNOPSYS CURRENTLY EXPECTS TO CHANGE THE MIX OF LICENSE TYPES UNDER WHICH
AVANT! PRODUCTS ARE SOLD WHICH WILL LOWER REVENUE ATTRIBUTABLE TO AVANT!
PRODUCTS IN THE SHORT TERM. Synopsys expects to change the mix of license
types under which Avant! products are sold to include a greater proportion
of licenses under which revenue is recognized ratably over the license term
rather than in the quarter of shipment. This change will result in a
reduction in reported revenue in the near term attributable to licenses of
Avant! products as compared to the revenue that would have been recognized
had the license mix not been changed. Conversely, the change in license mix
will result in an increase in backlog to be recognized as revenue in
subsequent periods attributable to licenses of Avant! products. Synopsys
expects that the change will reduce reported reveue by approximately $50
million for the remainder of fiscal 2002 and by approximately $60 million
in fiscal 2003.
o AVANT! HAS BEEN REQUIRED TO PAY SUBSTANTIAL AMOUNTS IN THE RECENT
RESOLUTION OF CRIMINAL LITIGATION, AND MIGHT BE REQUIRED TO PAY SUBSTANTIAL
ADDITIONAL AMOUNTS UNDER PENDING LAWSUITS. AVANT! AND ITS SUBSIDIARIES ARE
ENGAGED IN A NUMBER OF MATERIAL CIVIL LITIGATION MATTERS, INCLUDING A CIVIL
LITIGATION MATTER BROUGHT BY CADENCE, WHICH IN THIS DOCUMENT WE REFER TO AS
THE AVANT!/CADENCE LITIGATION. The Avant!/Cadence litigation generally
arises out of the same set of facts that were the subject of a criminal
action brought against Avant! and several individuals by the District
Attorney of Santa Clara County, California, which action we refer to as the
Santa Clara criminal action. Avant!, Gerald C. Hsu, Chairman of Avant! and
five former Avant! employees pled no contest to certain of the charges in
the Santa Clara criminal action. As part of that plea, Avant! paid
approximately $35.3 million in fines and a hearing was held on the amount
of restitution owed to Cadence. During the hearing, Cadence claimed losses
of $683.3 million. Ultimately, the court in the Santa Clara criminal action
required Avant! to pay Cadence restitution in the amount of $195.4 million.
That amount has been fully paid.
Cadence seeks compensatory damages and treble or other exemplary damages
from Avant! in the Avant!/Cadence litigation under theories of copyright
infringement, misappropriation of trade secrets, inducing breach of
contract and false advertising. Synopsys believes Avant! has defenses to
all of Cadence's claims in the Avant!/Cadence litigation. Cadence has not
fully quantified the amount of damages it seeks in the Avant!/Cadence
litigation. Should Cadence ultimately succeed in the prosecution of its
claims, however, Avant! could be required to pay substantial monetary
damages to Cadence. Some or all of these damages may be offset by the
$195.4 million restitution paid to Cadence in the Santa Clara criminal
action. Approximately $500 million in additional damages would be covered
by the insurance policy Synopsys has obtained with respect to the
Avant!/Cadence litigation, which is described below.
Injunctions entered in 1997 and 1998 enjoined Avant! from marketing its
early place and route products, ArcCell and Aquarius, based on a judicial
determination that they incorporated portions of Cadence's Design Framework
II source code, which in this document we refer to as DFII. The injunctions
also prohibit Avant! from possessing, using, selling or licensing any
product or work copied or derived from DFII and directly or indirectly
marketing, selling leasing, licensing, copying or transferring any of the
ArcCell or Aquarius products. Avant! ceased marketing, selling, leasing,
licensing or supporting all of the ArcCell or Aquarius products in 1996 and
1999, respectively. The DFII code is not incorporated in any current Avant!
product. Although Cadence has not made a claim in the Avant!/Cadence
litigation against any current Avant! product, including its Apollo and
Astro place and route products, and has not introduced any evidence that
any such product infringes Cadence's intellectual property rights, Cadence
has publicly implied that it intends to assert such claims. Synopsys
believes Avant! would have defenses to any such claims.
28
Nonetheless, should Cadence be successful at proving that any past or
then-current Avant! product incorporated intellectual property
misappropriated from Cadence, Avant! could be permanently enjoined from
further use of such intellectual property, which might require modification
to existing products and/or suspension of the sale of such products until
such Cadence intellectual property was removed.
Avant! is also engaged in other litigation matters. Avant! may have
obligations to indemnify some or all of the defendants in three shareholder
derivative complaints, purportedly brought on behalf of and for the benefit
of Avant!, against the Avant! former Board of Directors seeking unspecified
damages related to compensation, the Avant!/Cadence litigation and the
Santa Clara criminal action. Sequence Design, Inc. filed an action against
Avant! alleging that Star-RC and Star-RCXT, Avant!'s key parasitic
extraction products, infringe a patent owned by Sequence and seeking
unspecified damages. Silicon Valley Research, Inc. filed an action against
Avant! alleging that Avant!'s use of Cadence trade secrets damaged it by
allowing Avant! to develop and market products more quickly and cheaply and
that were more attractive to customers. Renco Investment Company filed an
action against Avant! seeking over $43 million in rental payments and
related damages associated with Avant!'s lease of a property that it
assigned to Comdisco, Inc., which subsequently filed Chapter 11 bankruptcy
and rejected the lease. The Avant!/Cadence litigation, other existing
litigation and other potential litigation, regardless of the outcome, may
continue to result in substantial costs and expenses and significant
diversion of effort by management, and may negatively impact relationships
with customers. An adverse result in any of these pending litigation
matters could seriously harm Avant!'s and Synopsys' business, financial
condition and results of operations.
Avant! has recently made significant payments to settle outstanding
litigation. In April 2001, Avant! paid $47.5 million to settle two class
actions that alleged securities law violations related to the
Avant!/Cadence litigation. On the closing date, Avant! paid the final
installment of a $5.4 million payment to settle claims between it and
Dynasty Capital Services LLC and Randolph L. Tom. In June 2002, Avant! paid
$20.5 million to Silvaco to settle claims for defamation and intentional
interference with economic advantage.
o THE INSURER UNDER THE LITIGATION PROTECTION INSURANCE RELATING TO THE
AVANT!/CADENCE LITIGATION MAY BE PREVENTED FROM PAYING FOR CERTAIN LOSSES
ON THE GROUNDS THAT SUCH PAYMENT VIOLATES PUBLIC POLICY. Synopsys has
entered into a policy with a subsidiary of American International Group,
Inc., an insurance company rated AAA by Standard & Poors. Under the policy,
insurance will be provided to pay Synopsys an amount equaling amounts paid
in a settlement or final adjudication of the Avant!/Cadence litigation,
including compensatory, exemplary and punitive damages, penalties, fines,
attorneys' fees and certain indemnification costs arising out of the
Avant!/Cadence litigation. The policy does not provide coverage for
litigation other than the Avant!/Cadence litigation. In exchange for a
binding fee of $10 million paid by Synopsys, the insurer has provided the
coverage, which became effective following the closing of the Avant!
acquisition. The fee was paid by Synopsys to the insurer on or about the
time of the closing of the Avant! acquisition and was credited against the
premium to make the insurance effective. In return for a premium of $335
million, including the $10 million binding fee, the insurer is obligated to
pay covered loss up to a limit of liability equaling (a) $500 million plus
(b) interest accruing at the fixed rate of 2%, compounded semi- annually,
on $250 million, less previous losses. The policy will expire upon a final
judgment or settlement of the Avant!/Cadence litigation or any earlier date
upon Synopsys' election. Upon such expiration, Synopsys will be entitled to
a payment equal to $240 million plus interest calculated as set forth above
less any loss paid under the policy, other than the first $10 million of
litigation expenses.
In some jurisdictions, it is against public policy to provide insurance for
willful acts, punitive damages or similar claims. This could potentially
affect the validity and enforceability of certain elements of the
litigation protection policy. The legal agreement governing the litigation
protection insurance expressly provides that the agreement will be governed
by the laws of the State of Delaware and that any disputes arising out of
or relating to the agreement will be resolved in the courts of the State of
Delaware. Synopsys believes, based upon advice it has received from
Delaware counsel, that a Delaware court would enforce both of these
provisions, and moreover would enforce the arrangement under Delaware law,
including to the extent it provides for insurance for Avant!'s willful acts
and punitive damages. Nonetheless, there can be no assurance in this
regard. In other cases, courts, including courts in California, have
applied local law to insurance contracts irrespective of the parties'
choice of law. Thus a court in a state other than Delaware could assert
jurisdiction over the enforceability of this agreement and rule pursuant to
the law of a state other than Delaware that the litigation protection
insurance is not enforceable in whole or in part on grounds of public
policy. For example, if there were to be litigation before a California
court regarding the enforceability of the insurance policy, despite the
parties' agreement that all disputes arising out of or relating to the
agreement be resolved in the courts of the State of Delaware, it is
possible that a California court might rule that, based upon the
relationship of Synopsys, Avant!, Cadence and/or the Avant!/Cadence
litigation to California, the enforceability of the litigation protection
insurance should be governed by California law and that Section 533 of the
California Insurance Code or another aspect of California law prevents the
insurer from paying certain losses in whole or in part.
29
A Delaware court might abide by such a ruling of a California court. To the
extent the insurer is prevented from paying certain losses on grounds of
public policy that would otherwise be covered by the insurance, Avant! will
be required to pay that portion of the losses and the insurer may be
obligated to refund a portion of the premium to Synopsys.
o SYNOPSYS DOES NOT HAVE CONTROL OVER THE AVANT!/CADENCE LITIGATION OR THE
AUTHORITY TO SETTLE THE AVANT!/CADENCE LITIGATION EXCEPT IN LIMITED
CIRCUMSTANCES. Under the terms of the litigation protection insurance
obtained by Synopsys to protect itself with respect to the Avant!/Cadence
litigation described above, which became effective following the
acquisition, the insurer has the right to exercise full control over the
defense of the Avant!/Cadence litigation, including both the strategy and
tactics to be employed. Further, the insurer has the right to exclusively
control the negotiation, discussion and terms of any proposed settlement,
except that Synopsys retains the right to settle the Avant!/Cadence
litigation, with the consent of the insurer, for up to $250 million plus
accrued interest less certain costs, and Synopsys and the defendants in the
Avant!/Cadence litigation each retain the right to consent or reasonably
withhold consent to any settlement terms proposed by the insurer which are
non-monetary and can be satisfied only by future performance or
non-performance by Synopsys or such defendants, as the case may be.
Therefore, Synopsys has a severely limited ability to control any risks
associated with, and the timing related to, any liabilities resulting from
the Avant!/Cadence litigation.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information relating to quantitative and qualitative disclosure about market
risk is set forth under the captions "Interest Rate Risk" and "Foreign Currency
Risk" in Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations. Such information is incorporated herein by reference.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits
10.1 Consulting Services Agreement between Synopsys, Inc. and A. Richard Newton
dated November 1, 2001 (compensatory plan or agreement in which an
executive officer or director participates)
(b.) Reports on Form 8-k
None.
SIGNATURES
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.
SYNOPSYS, INC.
By: /S/ ROBERT B. HENSKE
---------------------
Robert B. Henske
Senior Vice President,
Finance and Operations, and
Chief Financial Officer
(Principal Financial Officer)
Date: June 14, 2002
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