Table of Contents

 

 

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 JANUARY 31, 2009

 

OR

 

o

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

 

FOR THE TRANSITION PERIOD FROM          TO          

 

COMMISSION FILE NUMBER: 0-19807

 

SYNOPSYS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE		56-1546236
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

 

700 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043

(Address of principal executive offices, including zip code)

 

(650) 584-5000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x				Accelerated filer   o
Non-accelerated filer   o		(Do not check if a smaller reporting company)		Smaller reporting company o

 

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

 

Yes  o   No  x

 

As of March 6, 2009, there were 143,436,108 shares of the registrant’s common stock outstanding.

 

 

Table of Contents

 

SYNOPSYS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE FISCAL QUARTER ENDED JANUARY 31, 2009

 

TABLE OF CONTENTS

 

				Page
PART I.		Financial Information		1
ITEM 1.		Financial Statements		1
		Unaudited Condensed Consolidated Balance Sheets		1
		Unaudited Condensed Consolidated Statements of Operations		2
		Unaudited Condensed Consolidated Statements of Cash Flows		3
		Notes to Unaudited Condensed Consolidated Financial Statements		4
ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
ITEM 3.		Quantitative and Qualitative Disclosures About Market Risk		22
ITEM 4.		Controls and Procedures		22
PART II		Other Information		23
ITEM 1		Legal Proceedings		23
ITEM 1A.		Risk Factors		23
ITEM 2.		Unregistered Sales of Equity Securities and Use of Proceeds		31
ITEM 3.		Defaults Upon Senior Securities		32
ITEM 4.		Submission of Matters to a Vote of Security Holders		32
ITEM 5.		Other Information		32
ITEM 6.		Exhibits		32
Signatures				33

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value amounts)

 

		January 31, 2009			October 31, 2008
ASSETS
Current assets:
Cash and cash equivalents		$	470,165		$	577,632
Short-term investments		372,116			373,669
Total cash, cash equivalents and short-term investments		842,281			951,301
Accounts receivable, net		150,083			147,365
Deferred income taxes		136,533			133,609
Income taxes receivable		49,534			49,859
Other current assets		42,936			40,156
Total current assets		1,221,367			1,322,290
Property and equipment, net		141,152			145,087
Goodwill		917,794			899,640
Intangible assets, net		109,870			114,760
Long-term deferred income taxes		168,070			177,386
Other long-term assets		78,405			83,315
Total assets		$	2,636,658		$	2,742,478
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	182,608		$	289,769
Accrued income taxes		9,395			14,496
Deferred revenue		547,343			604,718
Total current liabilities		739,346			908,983
Long-term accrued income taxes		154,679			152,745
Deferred compensation and other liabilities		76,882			76,970
Long-term deferred revenue		61,636			75,409
Total liabilities		1,032,543			1,214,107
Stockholders’ equity:
Preferred Stock, $0.01 par value: 2,000 shares authorized; none outstanding		—			—
Common Stock, $0.01 par value: 400,000 shares authorized; 142,010 and 141,786 shares outstanding, respectively		1,420			1,418
Capital in excess of par value		1,482,555			1,471,031
Retained earnings		485,175			434,057
Treasury stock, at cost: 15,261 and 15,485 shares, respectively		(337,892		)	(342,856		)
Accumulated other comprehensive loss		(27,143		)	(35,279		)
Total stockholders’ equity		1,604,115			1,528,371
Total liabilities and stockholders’ equity		$	2,636,658		$	2,742,478

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

		Three Months Ended January 31,
		2009			2008
Revenue:
Time-based license		$	285,052		$	267,860
Upfront license		18,327			12,521
Maintenance and service		36,376			35,084
Total revenue		339,755			315,465
Cost of revenue:
License		41,823			40,398
Maintenance and service		15,579			15,879
Amortization of intangible assets		8,022			5,033
Total cost of revenue		65,424			61,310
Gross margin		274,331			254,155
Operating expenses:
Research and development		97,807			92,514
Sales and marketing		77,384			77,370
General and administrative		27,182			23,841
In-process research and development		600			—
Amortization of intangible assets		3,786			6,591
Total operating expenses		206,759			200,316
Operating income		67,572			53,839
Other income, net		2,099			6,330
Income before provision for income taxes		69,671			60,169
Provision for income taxes		17,242			13,724
Net income		$	52,429		$	46,445
Net income per share:
Basic		$	0.37		$	0.32
Diluted		$	0.37		$	0.31
Shares used in computing per share amounts:
Basic		141,865			146,001
Diluted		142,612			150,683

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Three Months Ended January 31,
		2009			2008
Cash flow from operating activities:
Net income		$	52,429		$	46,445
Adjustments to reconcile net income to net cash used in operating activities:
Amortization and depreciation		25,418			25,333
Share-based compensation		14,143			15,644
Allowance for doubtful accounts		1,490			—
Write-down of long-term investments		2,960			—
(Gain) loss on sale of investments		(172		)	200
Deferred income taxes		8,340			(1,858		)
Net change in deferred gains and losses on cash flow hedges		3,648			2,104
In-process research and development		600			—
Net changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable		(2,911		)	(17,077		)
Other current assets		(2,009		)	(1,185		)
Other long-term assets		407			(488		)
Accounts payable and accrued liabilities		(101,970		)	(81,102		)
Accrued income taxes		(5,771		)	2,754
Deferred revenue		(79,456		)	(42,969		)
Deferred compensation and other liabilities		928			1,018
Net cash used in operating activities		(81,926		)	(51,181		)
Cash flows from investing activities:
Proceeds from sales and maturities of short-term investments		64,047			150,523
Purchases of short-term investments		(60,059		)	(173,675		)
Purchases of long-term investments		—			(1,500		)
Purchases of property and equipment		(8,258		)	(9,726		)
Cash paid for acquisitions		(27,333		)	—
Capitalization of software development costs		(720		)	(704		)
Net cash used in investing activities		(32,323		)	(35,082		)
Cash flows from financing activities:
Principal payments on capital leases		(492		)	—
Issuances of common stock		1,152			12,097
Purchases of treasury stock		—			(82,865		)
Net cash provided by (used in) financing activities		660			(70,768		)
Effect of exchange rate changes on cash and cash equivalents		6,122			5,759
Net change in cash and cash equivalents		(107,467		)	(151,272		)
Cash and cash equivalents, beginning of year		577,632			579,327
Cash and cash equivalents, end of period		$	470,165		$	428,055

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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SYNOPSYS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1.     Description of Business

 

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

 

Note 2.     Summary of Significant Accounting Policies

 

The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).  Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP).  In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its financial position, results of operations and cash flows.  The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year.  These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys’ Annual Report on Form 10-K for the fiscal year ended October 31, 2008 filed with the SEC on December 22, 2008.

 

To prepare financial statements in conformity with GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes.  Actual results could differ from these estimates and may result in material effects on the Company’s operating results and financial position.

 

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

 

Fiscal Year End.  The Company has adopted a fiscal year ending on the Saturday nearest to October 31. The Company’s first fiscal quarter ended on January 31, 2009.  Fiscal 2009 is a 52-week fiscal year.  For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes refer to the applicable calendar month end.

 

Note 3.     Fair Value Measurements of Financial Assets and Liabilities

 

Effective November 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes guidelines and enhances disclosures for fair value measurements.  In February 2008, the Financial Accounting Standards Board (FASB) issued Staff Position (FSP) FSP 157-2, “Effective Date of FASB Statement No. 157” (FSP 157-2). FSP 157-2 delays the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until the Company’s fiscal year 2010. SFAS 157 clarifies the definition of fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  In addition to defining fair value, SFAS 157 establishes a three-tier fair value hierarchy that encourages the use of observable inputs but allows for unobservable inputs when observable inputs do not exist:

 

Level 1 —Observable inputs that reflect quoted prices (unadjusted) for identical instruments in active markets;

 

Level 2 —Observable inputs other than quoted prices included in Level 1 for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-driven valuations in which all significant inputs and significant value drivers are observable in active markets; and

 

Level 3 —Unobservable inputs to the valuation derived from fair valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. In accordance with SFAS 157, the Company’s cash equivalents, short-term investments, and marketable equity security are classified within Level 1 or Level 2. These classifications are based on the

 

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fact that cash equivalents and marketable securities are valued using quoted market prices in an active market or alternative pricing sources and models utilizing market observable inputs.

 

The Company’s foreign currency derivative contracts are classified within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments.

 

The Company’s deferred compensation plan assets and liabilities are classified within Level 2 as the inputs to measure the fair value are only indirectly observable.  The deferred compensation plan assets and liabilities consist of mutual funds invested in domestic and international marketable securities.

 

The Company’s strategic investments in privately held companies are classified within Level 3 as most of the inputs used to value the investments are unobservable.

 

Assets/Liabilities Measured at Fair Value on a Recurring Basis

 

Assets and liabilities measured at fair value on a recurring basis are summarized below as of January 31, 2009:

 

					Fair Value Measurement at Reporting Date Using
Description (in thousands)		Total as of January 31, 2009			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets
Cash equivalents:
Money market funds and bank deposits		$	468,165		$	468,165		$	—		$	—
Municipal securities		2,000			—			2,000			—
Short-term investments:
Municipal securities		372,116			—			372,116			—
Other long-term assets:
Marketable equity security(1)		344			344			—			—
Deferred compensation plan assets		57,909			2			57,907			—
Total assets		$	900,534		$	468,511		$	432,023		$
Liabilities
Foreign currency derivative contracts		$	18,656		$	—		$	18,656		$	—
Deferred compensation plan liabilities		58,109			—			58,109			—
Total liabilities		$	76,765		$	—		$	76,765		$	—

 

(1) In the first quarter of fiscal 2009, the Company recorded $0.9 million of other-than-temporary impairment charges in other income, net, due to the decline of the stock price of a public company in our long-term investment portfolio.

 

Assets/Liabilities Measured at Fair Value on a Non-recurring Basis

 

Equity investments in privately-held companies are accounted for under the cost method of accounting.  These equity investments (also called non-marketable equity investments) are classified within Level 3 as they are valued using unobservable data or data in an inactive market.  The Company evaluates the fair value of each investment when an event or circumstance indicates an other-than-temporary decline in value has occurred.  In the first quarter of fiscal 2009, the Company determined one investment had impairment indicators and thus calculated the fair value of this investment by determining what a willing buyer would pay to purchase the investment using a financial model based on business enterprise value and calculating its liquidity preference.  The inputs to the financial model were based on cash flow projections.  As a result of the fair value measurement, the Company recorded $2.1 million of other-than-temporary impairment charges on the investment in other (loss) income, net, on the unaudited condensed consolidated statement of operations in the first quarter of fiscal 2009.

 

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The following table presents the balance of assets and liabilities measured at fair value on a non-recurring basis as of January 31, 2009, and losses recorded during the three months ended January 31, 2009:

 

Fair Value Measured Using

Quoted Prices

in Active

Significant

Total gains

Markets for

Other

Significant

(losses) for

Identical

Observable

Unobservable

three months

Total as of

Instruments

Inputs

Inputs

ended

(in thousands)

January 31, 2009

(Level 1)

(Level 2)

(Level 3)

January 31, 2009

Non-marketable equity investments

$

11,757

$

—

$

—

$

11,757

$

(2,090

)

 

Effective January 1, 2009, the Company also adopted SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an Amendment of FASB Statement No. 115. Under this statement, entities may choose to measure certain financial instruments and liabilities at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings. As of January 31, 2009, the Company did not elect such option for its financial instruments and liabilities.

 

Note 4.     Business Combinations

 

On December 18, 2008, the Company acquired the assets of a business for cash and incurred acquisition related costs.  The Company preliminarily allocated the total purchase consideration to the assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date, resulting in goodwill of $19.8 million, in process research and development expense of $0.6 million, and identifiable intangible assets of $6.9 million.  The intangible assets are being amortized over one to six years. Goodwill, which is deductible for tax purposes, represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and will not be amortized.

 

Other

 

During the first quarter of fiscal 2009, the Company paid $1.2 million for achievement of certain product milestones related to a prior acquisition. This payment was recorded as an adjustment to goodwill in the prior year.

 

Note 5.     Goodwill and Intangible Assets

 

Goodwill as of January 31, 2009 consisted of the following:

 

		(in thousands)
Balance at October 31, 2008		$	899,640
Addition(1)		19,837
Other adjustments(2)		(1,683		)
Balance at January 31, 2009		$	917,794

 

(1)           Addition relates to an acquisition of assets of a business in the first quarter fiscal of 2009 as described in Note 4.

 

(2)           Adjustments relate to reduction of merger costs and income tax adjustments for prior year acquisitions.

 

Intangible assets as of January 31, 2009 consisted of the following:

 

		Gross Assets			Accumulated Amortization			Net Assets
		(in thousands)
Core/developed technology		$	132,731		$	66,966		$	65,765
Customer relationships		174,620			140,468			34,152
Contract rights intangible		12,600			9,123			3,477
Covenants not to compete		3,100			2,160			940
Trademarks and trade names		2,700			471			2,229
Capitalized software development costs		9,524			6,217			3,307
Total		$	335,275		$	225,405		$	109,870

 

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Intangible assets as of October 31, 2008 consisted of the following:

 

		Gross Assets			Accumulated Amortization			Net Assets
		(in thousands)
Core/developed technology		$	128,231		$	59,577		$	68,654
Customer relationships		172,420			137,106			35,314
Contract rights intangible		12,500			8,362			4,138
Covenants not to compete		3,100			2,006			1,094
Trademarks and trade names		2,600			330			2,270
Capitalized software development costs		8,784			5,494			3,290
Total		$	327,635		$	212,875		$	114,760

 

Amortization expense related to intangible assets consisted of the following:

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Core/developed technology		$	7,389		$	4,562
Customer relationships		3,362			6,197
Contract rights intangible		761			688
Covenant not to compete		154			167
Trademark and trade names		141			10
Capitalized software development costs(1)		723			728
Total		$	12,530		$	12,352

 

(1)           Amortization of capitalized software development costs is included in cost of license revenue in the unaudited condensed consolidated statements of operations.

 

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

 

Fiscal Year		(in thousands)
Remainder of fiscal 2009		$	33,501
2010		32,376
2011		21,106
2012		13,056
2013		5,776
2014 and thereafter		4,055
Total		$	109,870

 

Note 6.     Accounts Payable and Accrued Liabilities

 

Accounts payable and accrued liabilities consisted of the following:

 

		January 31,			October 31
		2009			2008
		(in thousands)
Payroll and related benefits		$	114,749		$	188,344
Other accrued liabilities		57,202			74,297
Accounts payable		7,271			23,168
Acquisition related costs		3,386			3,960
Total		$	182,608		$	289,769

 

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Note 7.     Credit Facility

 

On October 20, 2006, the Company entered into a five-year, $300.0 million senior unsecured revolving credit facility providing for loans to the Company and certain of its foreign subsidiaries. The amount of the facility may be increased by up to an additional $150.0 million through the fourth year of the facility. The facility contains financial covenants requiring the Company to maintain a minimum leverage ratio and specified levels of cash, as well as other non-financial covenants. The facility terminates on October 20, 2011. Borrowings under the facility bear interest at the greater of the administrative agent’s prime rate or the federal funds rate plus 0.50%; however, the Company has the option to pay interest based on the outstanding amount at Eurodollar rates plus a spread between 0.50% and 0.70% based on a pricing grid tied to a financial covenant. In addition, commitment fees are payable on the facility at rates between 0.125% and 0.175% per year based on a pricing grid tied to a financial covenant. As of January 31, 2009, the Company had no outstanding borrowings under this credit facility and was in compliance with all the covenants.

 

Note 8.     Comprehensive Income

 

The following table presents the components of comprehensive income:

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Net income		$	52,429		$	46,445
Unrealized gain on investments, net of tax of ($1,625) and ($677), respectively		2,462			1,026
Deferred gain on cash flow hedges, net of tax of ($1,354) and ($779), respectively		2,294			2,104
Reclassification adjustment on deferred loss (gain) on cash flow hedges, net of tax of ($1,126) and $188, respectively		4,253			(1,100		)
Foreign currency translation adjustment		(873		)	(2,373		)
Total		$	60,565		$	46,102

 

Note 9.                 Stock Repurchase Program

 

The Company is authorized to purchase up to $500.0 million of its common stock under a stock repurchase program originally established by the Company’s Board of Directors (Board) in December 2004 and replenished to $500.0 million in March 2007.  The Company repurchases shares to offset dilution caused by ongoing stock issuances from existing plans for equity compensation awards, acquisitions, and when management believes it is a good use of cash.  Repurchases are transacted in accordance with Rule 10b-18 under the Securities Exchange Act of 1934 (Exchange Act) through open market purchases, plans executed under Rule 10b5-1 under the Exchange Act and structured transactions.

 

There were no stock repurchases during the three months ended January 31, 2009. During the three months ended January 31, 2008, the Company purchased 3.4 million shares at an average price of $24.27 per share for an aggregate purchase price of $82.9 million. During the three months ended January 31, 2009 and 2008, approximately 0.2 million and 0.7 million shares were reissued, respectively, for employee share-based compensation requirements. As of January 31, 2009, $209.7 million remained available for future purchases under the program.

 

Note 10.    Share-based Compensation

 

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

 

As of January 31, 2009, there was $93.2 million of unamortized share-based compensation expense which is expected to be amortized over a weighted-average period of approximately 3.3 years. The intrinsic values of options exercised during the three months ended January 31, 2009 and 2008, were $0.2 million and $5.1 million, respectively.

 

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The compensation cost recognized in the unaudited condensed consolidated statements of operations for these share-based compensation arrangements was as follows for the first quarters of fiscal years 2009 and 2008:

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Cost of license		$	1,644		$	1,328
Cost of maintenance and service		547			1,342
Research and development expense		5,979			6,419
Sales and marketing expense		3,121			3,700
General and administrative expense		2,852			2,855
Share-based compensation expense before taxes		14,143			15,644
Income tax benefit		(3,078		)	(3,618		)
Share-based compensation expense after taxes		$	11,065		$	12,026

 

Note 11.   Net Income per Share

 

The Company computes basic income per share by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects the dilution of potential common shares outstanding such as stock options and unvested restricted stock units and awards during the period using the treasury stock method.

 

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

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Numerator:
Net income		$	52,429		$	46,445
Denominator:
Weighted-average common shares for basic net income per share		141,865			146,001
Dilutive effect of common share equivalents from share-based compensation		747			4,682
Weighted-average common shares for diluted net income per share		142,612			150,683
Net income per share:
Basic		$	0.37		$	0.32
Diluted		$	0.37		$	0.31

 

Diluted net income per share excludes 23.3 million and 8.8 million of anti-dilutive stock options and unvested restricted stock units and awards for the three months ended January 31, 2009 and 2008, respectively. While these stock options and unvested restricted stock units and awards were anti-dilutive for the respective periods, they could be dilutive in the future.

 

Note 12.         Segment Disclosure

 

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

 

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

 

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The following table presents the revenues related to operations by geographic areas:

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Revenue:
United States		$	165,457		$	160,710
Europe		49,084			49,295
Japan		69,948			52,473
Asia Pacific and Other		55,266			52,987
Consolidated		$	339,755		$	315,465

 

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

 

One customer accounted for more than ten percent of the Company’s consolidated revenue in the three months ended January 31, 2009 and 2008.

 

Note 13.         Other Income, net

 

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

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Interest income		$	3,643		$	7,016
Loss on assets related to executive deferred compensation plan		(4,018		)	(492		)
Foreign currency exchange gain		3,401			794
Other, net		(927		)	(988		)
Total		$	2,099		$	6,330

 

Note 14.   Taxes

 

Effective Tax Rate

 

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

 

The following table presents the provision for income taxes and the effective tax rates:

 

		Three Months Ended January 31,
		2009			2008
		(in thousands)
Income before income taxes		$	69,671		$	60,169
Provision for income tax		$	17,242		$	13,724
Effective tax rate		24.7		%	22.8		%

 

The Company’s effective tax rate for the three months ended January 31, 2009 is lower than the statutory federal income tax rate of 35% primarily due to the tax impact of non-U.S. operations, which are taxed at lower rates, and research and development credits, partially offset by state taxes and non-deductible share-based compensation recorded under SFAS 123(R). The effective tax rate increased in the three months ended January 31, 2009, as compared to the same period in fiscal 2008, primarily due to a decrease in tax exempt investment income and changes in mix of geographical earnings, partially offset by the recognition of a prior year foreign tax benefit.  During the three months ended January 31, 2009, there were no other material changes to the total gross unrecognized tax benefits.

 

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The timing of the resolution of income tax examinations is highly uncertain as well as the amounts and timing of various tax payments that are part of the settlement process. This could cause large fluctuations in the balance sheet classification of current and non-current assets and liabilities. The Company believes that in the next twelve months it is reasonably possible that the statute of limitations on certain state and foreign income and withholding taxes will expire, and that certain federal and foreign transfer pricing issues could be effectively settled. Given the uncertainty as to ultimate settlement terms, the timing of payment and the impact of such settlements on other uncertain tax positions, the range of the estimated potential decrease in underlying unrecognized tax benefits is between $0 and $74 million.  See IRS Examinations below for the status of current federal income tax audits.

 

On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “Act”), which has significant tax implications for certain businesses and individuals.  The Company has not yet fully analyzed all provisions of the Act but does not anticipate it having a material impact on our effective tax rate for fiscal 2009.

 

IRS Examinations

 

The Company is regularly audited by the IRS.

 

On June 30, 2008, the Appeals Office of the IRS and the Company executed a final Closing Agreement with respect to a Revenue Agent’s Report (RAR) received for the audit of fiscal years 2000 and 2001, in connection with a transfer pricing dispute.  As a result of the Closing Agreement and the Company’s concurrent evaluation of its ability to use certain foreign tax credits, the Company’s provision for income taxes in its third fiscal quarter of 2008 included a net income tax benefit (net of decreases in related deferred tax assets) of $17.3 million.

 

In July 2008, the IRS completed its field examination of fiscal years 2002-2004 and issued an RAR in which the IRS proposed an adjustment that would result in an aggregate tax deficiency for the three year period of approximately $236.2 million, $130.5 million of which would be a reduction of certain tax losses and credits that would otherwise be available either as refund claims or to offset taxes due in future periods. The IRS is contesting the Company’s tax deduction for payments made in connection with litigation between Avant! Corporation and Cadence Design Systems, Inc. In addition, the IRS has asserted that the Company is required to make an additional transfer pricing adjustment with a wholly owned non-U.S. subsidiary as a result of the Company’s acquisition of Avant! in 2002. The IRS has also proposed adjustments to the Company’s transfer pricing arrangements with its foreign subsidiaries, deductions for foreign trade income and certain temporary differences. The Company has agreed to additional taxes of approximately $20.0 million for these proposed adjustments, which have been fully provided for in prior years. The total adjustments proposed by the IRS, if sustained, would also result in additional state taxes (net of the federal tax benefit for state taxes paid) of approximately $17 million. The IRS imposes interest on any resulting tax deficiencies. The Company strongly believes the proposed IRS adjustment and resulting proposed deficiency are inconsistent with applicable tax laws, and that the Company has meritorious defenses to this proposed IRS adjustment. On August 9, 2008, the Company timely filed a protest with the IRS and intends to seek resolution of these issues through the Appeals Office, which could take several years.  The Company continues to discuss a resolution of this matter with the examination division, which, if successful, could settle the matter within the next twelve months.  The Company believes it has adequately provided for potential tax liabilities related to these years.

 

Note 15.   Contingencies

 

See also the disclosure in Note 14 above regarding the IRS Revenue Agent’s Report.

 

Other Proceedings

 

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

 

Note 16.   Effect of New Accounting Pronouncements

 

The effect of recent accounting pronouncements has not changed from the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2008.

 

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

 

This Quarterly Report on Form 10-Q, and in particular the following discussion, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the Securities Act) and Section 21E of the Securities Exchange Act of 1934 (the Exchange Act). These statements include but are not limited to statements concerning: o ur business, product and platform strategies, expectations regarding previous and future acquisitions; completion of development of our unfinished products, or further development or integration of our existing products; continuation of current industry trends towards vendor consolidation; expectations regarding our license mix; expectations regarding customer interest in more highly integrated tools and design flows; expectations of the success of our intellectual property and design for manufacturing initiatives; expectations concerning recent completed acquisitions; expectations regarding the likely outcome of the Internal Revenue Service’s proposed net tax deficiencies for fiscal years 2000 through 2004 and other outstanding litigation; expectations that our cash, cash equivalents and short-term investments and cash generated from operations will satisfy our business requirements for the next 12 months; and our expectations of our future liquidity requirements. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including, without limitation, those identified below in Part II, Item 1A of this Form 10-Q. The words “may,” “will,” “could,” “would,” “anticipate,” “expect,” “intend,” “believe,” “continue,” or the negatives of these terms, or other comparable terminology and similar expressions identify these forward-looking statements. However, these words are not the only means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements.  The information included herein is given as of the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC) and future events or circumstances could differ significantly from these forward-looking statements. Accordingly, we caution readers not to place undue reliance on these statements. Unless required by law, we undertake no obligation to update publicly any forward-looking statements.  All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and in other documents we file from time to time with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.

 

The following summary of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this report and with our audited consolidated financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2008, filed with the SEC on December 22, 2008.

 

Fiscal Year End.   Our fiscal year ends on the Saturday nearest to October 31. Our first fiscal quarter ended on January 31, 2009.  Fiscal 2009 is a 52-week fiscal year.  For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes refer to the applicable calendar month end.

 

Overview

 

Business Environmen t Summary

 

We are a world leader in electronic design automation (EDA) software and related services for semiconductor design companies. We offer a broad portfolio of solutions that are highly integrated to solve our customers’ needs at each stage of the semiconductor chip design process. We deliver technology-leading semiconductor design and verification software platforms and integrated circuit (IC) manufacturing software products to the global electronics market, enabling the development and production of complex systems-on-chips (SoCs). In addition, we provide intellectual property (IP), system-level design hardware and software products, and design services to simplify the design process and accelerate time-to-market for our customers. Finally, we provide software and services that help customers prepare and optimize their designs for manufacturing.

 

We generate a substantial majority of our revenue from large customers in the semiconductor and electronics industries. Our customers typically fund purchases of our software and services largely out of their research and development (R&D) budgets and, to a lesser extent, their manufacturing and capital budgets. Our customers continually face the competing challenges of developing increasingly advanced electronics products while reducing their design and manufacturing costs in order to meet ongoing consumer demand for lower prices. Our customers’ business outlook and willingness to invest in new and increasingly complex chip designs affect their spending decisions and vendor selections. The recent crisis in the financial markets and the continued weakening of the global economy have exacerbated these challenges.

 

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Our customers bargain on various aspects of the contractual arrangements they make with us. Our customers often demand a broader portfolio of solutions, support and services and seek more favorable terms such as expanded license usage, future purchase rights and other unique rights at an overall lower total cost of design. Our customer arrangements are complex, involving hundreds of products and various license rights. No one factor drives our customers’ buying decisions and we compete on all fronts to capture a higher portion of our customers’ budgets in a highly competitive EDA market. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes. Collectively, the increase in the value of all of our customer contracts is the primary driver of our overall growth in revenue over time. As further described below, the effect of an increase in value for a particular customer is typically recognized over the life of the customer contract rather than in one particular period.

 

Our business model allows a substantial majority of our customers to pay for licenses over a period of time and generates recurring revenue for us over a period of time, generally three years. We continue to target achieving greater than 90% of our total revenue as recurring revenue, which we refer to in our financial statements as time-based license and maintenance and service revenue.  Accordingly, most of the revenue we recognize in any particular quarter results from our selling efforts in each of the prior periods during the last three or so years rather than from efforts or changes in the current period.  The timing of orders is less important to us in the short term and we have been able to resist typical software industry quarter-end pressures and to avoid business with terms, including pricing terms, which may be less favorable to us.

 

Short-term fluctuations in industry or general economic conditions or in orders generally do not immediately affect our financial results due to our business model. While the electronics, semiconductor and EDA industries are currently experiencing unprecedented uncertainty and weakness due to the recent severe downturn in the global economy, to date, our business model has substantially protected our financial results. Nevertheless, if the downturn persists or worsens for any extended period of time, our future revenues and financial results would be negatively affected.   The turmoil and uncertainty about future economic conditions could cause our customers to postpone their decision-making, decrease their spending, delay their payments, consolidate with other customers, or file for bankruptcy protection, any of which could adversely affect our business and our future revenues. The downturn has negatively impacted several of our competitors, and a few have recently announced lower revenues than they had previously expected. We will continue to monitor market conditions and make adjustments to our business in order to reduce the adverse impact that a prolonged economic downturn could have on our business.

 

Financial Performance Summary for the Three Months Ended January 31, 2009

 

·       Total revenue of $339.8 million was up 8% from $315.5 million in the same quarter in fiscal 2008. The increase was primarily attributable to bookings of Technology Subscription Licenses (TSLs) in prior periods which increase time-based revenue recognized in later periods and to a lesser extent from Synplicity product sales from our acquisition in May 2008.

 

·       Time-based license revenue of $285.1 million was up 6% from $267.9 million in the same quarter in fiscal 2008. The increase was primarily attributable to bookings of TSLs in prior periods which increase time-based revenue recognized in later periods.

 

·       Upfront license revenue of $18.3 million was up 46% from $12.5 million in the same quarter in fiscal 2008. The increase reflected the impact of Synplicity product sales.

 

·       We derived approximately 95% of our total revenue from time-based, maintenance and services revenues, and 5% from upfront revenue in the first quarter of fiscal 2009, compared to approximately 96% and 4%, respectively, in the same quarter in fiscal 2008. This reflects our adherence to our business model.

 

·       Maintenance revenue of $20.7 million was up 26% from $16.4 million in the same quarter in fiscal 2008. The increase was primarily attributable to the increase in Synplicity product sales which were mostly perpetual based.  Professional services and other revenue of $15.7 million was down 16% from $18.7 million in the same quarter in fiscal 2008. The decrease was primarily driven by the timing of completion of performed milestones under service contracts.

 

·       Net income of $52.4 million was up 13% from $46.4 million in the same quarter in fiscal 2008. The increase was primarily due to increases in revenues and cost control efforts.

 

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 Critical Accounting Policies and Estimates

 

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

 

The accounting policies that most frequently require us to make assumptions, judgments and estimates, and therefore are critical to understanding our results of operations, are:

 

·                   Revenue recognition; and

 

·                   Income taxes.

 

We describe our revenue recognition and income taxes policies below. Our remaining critical accounting policies and estimates are discussed in Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2008, filed with the SEC on December 22, 2008.

 

Revenue Recognition

 

We recognize revenue from software licenses and related maintenance and service revenue and, to a lesser extent, from hardware sales. Software license revenue consists of fees associated with the licensing of our software. Maintenance and service revenue consists of maintenance fees associated with perpetual and term licenses and professional service fees.

 

We have designed and implemented revenue recognition policies in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended, and EITF 00-21, Revenue Arrangements with Multiple Deliverables.

 

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

·                   Technology Subscription Licenses (TSLs) are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. We bundle and do not charge separately for post-contract customer support (maintenance) for the term of the license.

 

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

 

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

 

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

 

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

 

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

 

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·

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

 

We generally recognize revenue from hardware sales in full upon shipment if all other revenue recognition criteria are met. If a technology subscription license is sold together with the hardware, we recognize revenue ratably over the term of the software license period, or as customer installments become due and payable, whichever is later. Revenue attributable to these hardware sales is reported as “upfront license revenue” in the unaudited condensed consolidated statement of operations.

 

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

 

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

 

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

 

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

 

	·	Persuasive Evidence of an Arrangement Exists. Prior to recognizing revenue on an arrangement, our customary policy is to have a written contract, signed by both the customer and us or a purchase order from those customers that have previously negotiated a standard end-user license arrangement or purchase agreement.
	·	Delivery Has Occurred. We deliver our products to our customers electronically or physically. For electronic deliveries, delivery occurs when we provide access to our customers to take immediate possession of the software by downloading it to the customer’s hardware. For physical deliveries, the standard transfer terms are typically FOB shipping point. We generally ship our products or license keys promptly after acceptance of customer orders. However, a number of factors can affect the timing of product shipments and, as a result, timing of revenue recognition, including the delivery dates requested by customers and our operational capacity to fulfill product orders at the end of a quarter.
	·	The Fee is Fixed or Determinable. Our determination that an arrangement fee is fixed or determinable depends principally on the arrangement’s payment terms. Our standard payment terms for perpetual and term licenses require 75% or more of the license fee to be paid within one year. If the arrangement includes these terms, we regard the fee as fixed or determinable, and recognize all license revenue under the arrangement in full upon delivery (assuming all other revenue recognition criteria are met). If the arrangement does not include these terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable. In the case of a TSL, because of the right to exchange products or receive unspecified future technology and because VSOE for maintenance services does not exist for a TSL, we recognize revenue ratably over the term of the license, but not in advance of when customers’ installments become due and payable, even if the fee is otherwise fixed or determinable.

 

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·

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

 

Income Taxes

 

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

 

We recognize deferred tax assets and liabilities for the temporary differences between the book and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. In evaluating our ability to utilize our deferred tax assets, we consider all available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income on a jurisdiction by jurisdiction basis, as well as feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. We believe that the net deferred tax assets of approximately $294 million that are recorded on our balance sheet will ultimately be realized. However, if we determine in the future that it is more likely than not we will not be able to realize a portion or the full amount of deferred tax assets, we would record an adjustment to the deferred tax asset valuation allowance as a charge to earnings in the period such determination is made.

 

Included in our net deferred tax assets as of October 31, 2008 are federal foreign tax credits of $70.1 million of which $63.9 million will expire from fiscal 2013 through 2018.  The remaining $6.2 million in foreign tax credits are from acquired companies, which have a valuation allowance of $3.4 million, and will expire between fiscal 2009 and 2017. Foreign tax credits can only be carried forward ten years, unlike net operating loss and federal research credit carryforwards that have a twenty year carryforward period, and may only be used after foreign tax credits arising in each subsequent year have been used first. Our ability to utilize foreign tax credits is dependent upon having sufficient foreign source income during the carryforward period. We have recorded a valuation allowance of $19.7 million with respect to our foreign tax credit carryforward, of which $14.6 million was recorded as a result of the 2000-2001 final IRS settlement. See Results of Operations—Income Taxes—IRS Examinations, below, and Note 14 of Notes to Unaudited Condensed Consolidated Financial Statements . The need for a valuation allowance with respect to foreign tax credits is subject to change based upon a number of factors, including the amount of foreign tax credits arising in future years, our forecasts of future foreign source income, the amount of our undistributed earnings of our foreign subsidiaries and changes in income tax laws that may affect our ability to use such credits.

 

The calculation of tax liabilities involves the inherent uncertainty associated with the application of complex tax laws. We are also subject to examination by various taxing authorities. We believe we have adequately provided in our financial statements for potential additional taxes. If we ultimately determine that these amounts are not owed, we would reverse the liability and recognize the tax benefit in the period in which we determine that the liability is no longer necessary. If an ultimate tax assessment exceeds our estimate of tax liabilities, we would record an additional charge to earnings. See Note 14 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of taxes and the Revenue Agent’s Reports from the IRS we received in June 2005 and July 2008 asserting very large net increases to our U.S. tax arising from the audit of fiscal 2000 through 2001 and fiscal 2002 through 2004, respectively.

 

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Results of Operations

 

Revenue Background

 

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

 

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

 

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

 

Total Revenue

 

		January 31,
		2009			2008			$ Change			% Change
		(dollars in millions)
Three months ended		$	339.8		$	315.5		$	24.3		8	%

 

The increase in total revenue for the first quarter of fiscal 2009 compared to the same quarter of fiscal 2008 was primarily due to our time-based license model which reflects prior period bookings contributing to current period time-based revenue and, to a lesser extent, product sales from our Synplicity acquisition in May 2008.

 

Time-Based License Revenue

 

		January 31,
		2009			2008			$ Change			% Change
		(dollars in millions)
Three months ended		$	285.1		$	267.9		$	17.2		6	%
Percentage of total revenue		84		%	85		%

 

The increase in time-based license revenue in the first quarter of fiscal 2009 compared to the same quarter in fiscal 2008 was primarily due to prior period bookings leading to increased current period time-based revenue.

 

Upfront License Revenue

 

		January 31,
		2009			2008			$ Change			% Change
		(dollars in millions)
Three months ended		$	18.3		$	12.5		$	5.8		46	%
Percentage of total revenue		5		%	4		%

 

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Upfront license revenue increased in the first quarter of fiscal 2009 compared to the same quarter in fiscal 2008, reflecting the presence of Synplicity product sales in the first quarter of fiscal 2009, as such sales were absent in the first quarter of fiscal 2008, and the normal fluctuations in customer license requirements which can drive the amount of upfront orders and revenue in any particular quarter.

 

Maintenance and Service Revenue

 

		January 31,
		2009			2008			$ Change			% Change
		(dollars in millions)
Three months ended
Maintenance revenue		$	20.7		$	16.4		$	4.3		26	%
Professional services and other revenue		15.7			18.7			(3.0		)	(16	)%
Total maintenance and service revenue		$	36.4		$	35.1		$	1.3		4	%
Percentage of total revenue		11		%	11		%

 

Maintenance revenue increased in the first quarter of fiscal 2009 compared to the same period in fiscal 2008 primarily because of the maintenance revenue stream on perpetual-based products, as well as the sale of perpetual licenses to the products that we acquired in our acquisition of Synplicity in the third quarter of fiscal 2008. We expect our second quarter of fiscal 2009 to similarly reflect the impact of the Synplicity acquisition on a year-over-year comparative basis, but do not expect the acquisition-related increases to continue thereafter.  In addition, some customers may in the future choose not to renew maintenance on upfront licenses for economic or other factors, which would lower our future maintenance revenue.

 

Professional services and other revenue decreased in the first quarter of fiscal 2009 compared to the same period in fiscal 2008 due principally to the timing of customer acceptance of services performed under ongoing contracts.

 

Events Affecting Cost of Revenues and Operating Expenses

 

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

 

Cost of Revenue

 

		January 31,
		2009			2008			$ Change			% Change
		(dollars in millions)
Three months ended
Cost of license revenue		$	41.8		$	40.4		$	1.4		3	%
Cost of maintenance and service revenue		15.6			15.9			(0.3		)	(2	)%
Amortization of intangible assets		8.0			5.0			3.0			60	%
Total		$	65.4		$	61.3		$	4.1		7	%
Percentage of total revenue		19		%	19		%

 

We divide cost of revenue into three categories: cost of license revenue, cost of maintenance and service revenue, and amortization of intangible assets. We segregate expenses directly associated with providing consulting and training from cost of license revenue associated with internal functions providing license delivery and post-customer contract support services. We then allocate these group costs between cost of license revenue and cost of maintenance and service revenue based on license and service revenue reported.

 

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

 

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

 

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