Magma Design Automation 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Amendment No. 1)
For the fiscal year ended April 2, 2006
For the transition period from to
COMMISSION FILE NO.: 0-33213
MAGMA DESIGN AUTOMATION, INC.
(Exact name of Registrant as specified in its charter)
1650 Technology Dr.
San Jose, California 95110
(Address, including zip code, and telephone number, including area code, of the registrants principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, par value $.0001 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the registrants common stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 30, 2005, the last business day of the registrants most recently completed second fiscal quarter, as reported on the Nasdaq National Market, was $231,234,799. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.
As of May 31, 2006 Registrant had outstanding 36,377,498 shares of Common Stock, $0.0001 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrants proxy statement to be delivered to the stockholders in connection with Registrants 2006 Annual Meeting of Stockholders to be held on August 29, 2006, are incorporated by reference into Part III of this Form 10-K. The Registrants proxy statement is required to be filed within 120 days after the Registrants fiscal year end.
MAGMA DESIGN AUTOMATION, INC.
ANNUAL REPORT ON FORM 10-K
Year ended April 2, 2006
TABLE OF CONTENTS
Magma, Blast Fusion, Blast Noise, QuickCap and SiliconSmart are registered trademarks, and ArchEvaluator, Blast RTL, Blast Power, Blast Plan, Blast Rail, Blast Create, Blast FPGA, Quartz Time, Blast DFT, Quartz RC, Quartz Formal, Quartz SSTA, Quartz DRC, Quartz LVS, Blast Yield, FineSim, Talus, The Fastest Path from RTL to Silicon, Signoff in the Loop, and PALACE are trademarks, of Magma Design Automation. All other product and company names are trademarks and registered trademarks of their respective companies.
This Amendment No. 1 on Form 10-K/A for the fiscal year ended April 2, 2006 (this Amendment No. 1) for Magma Design Automation, Inc. (the Company) is being filed to amend the items described below contained in the Companys Annual Report on Form 10-K originally filed with the Securities and Exchange Commission (the SEC) on June 15, 2006 (the Original Form 10-K). For the convenience of the reader, the Company has included in this Amendment No. 1 all other disclosures contained in its Original Form 10-K.
This Amendment No. 1 is being filed for the sole purpose of correcting an error in the Report of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP (the PWC Report).
This Amendment No. 1 sets forth the complete text of each item of the Original 10-K and the corrected PWC Report, and includes as Exhibits 23.1 and 23.2 new consents of Grant Thornton LLP and PricewaterhouseCoopers LLP, and includes as Exhibits 31.1, 31.2, 32.1 and 32.2 new certifications by the Companys Chief Executive Officer and Chief Financial Officer.
In order to preserve the nature and character of the disclosures set forth in such items as originally filed, this Amendment No. 1 does not reflect events occurring after the filing of the Original Form 10-K on June 15, 2006, or modify or update the disclosures presented in the Original Form 10-K, except to reflect the correction described above. Accordingly, this Amendment No. 1 should be read in conjunction with our filings made subsequent to the filing of the Original Form 10-K.
ITEM 1. BUSINESS.
Magma Design Automation, Inc. provides electronic design automation (EDA) software products and related services. Our software enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products comprise a digital integrated solution for the chip development cycle, from initial design through physical implementation.
Our software products allow chip designers to meet critical time-to-market objectives, improve chip performance and handle chip designs involving millions of components. Our flagship Blast and Talus family of products and our Quartz family of sign-off and verification tools combine into one integrated chip design and verification flow, from what traditionally had been separate logic design, physical design, and analysis and sign-off processes. This integrated flow significantly reduces design iterations, allowing our customers to accelerate the time it takes to design and produce deep submicron integrated circuits.
We provide consulting, training and services to help our customers more rapidly adopt our technology. We also provide post-contract support, or maintenance, for our products.
Evolution of the Electronic Design Automation Market
The trend toward deep submicron and system-on-chip designs has driven demand for improved electronic design automation software that enables the efficient design and implementation of these complex chips. Limitations in traditional electronic design automation technology could slow the adoption of deep submicron processes due to the difficulty in implementing designs at these small feature sizes. Historically, electronic design automation companies developed software for use by separate engineering groups to address either the front-end chip design or back-end chip implementation processes.
In the front-end design process, the chip design is conceptualized and written as a register transfer level computer program, or RTL file, that describes the required functionality of the chip. For large chips, the design is often divided into a number of individual blocks, each with its own associated RTL file. This is often done because of capacity limitations in existing electronic design automation tools. The designer also develops constraints for the design that are used to describe the desired timing performance of the chip. Finally, a target library is specified that contains detailed information about the basic functional building blocks, or logic gates, that will be used in the design. This library is typically provided by the semiconductor vendor or a third-party library vendor. The next step is to run the RTL files through synthesis software that generates a netlist. The netlist describes the circuit in terms of logic gates selected from the target library and connected such that the functionality specified in the RTL files is realized. The synthesis software also performs optimizations to attempt to meet the timing constraints specified by the designer.
A critical objective of chip design is to minimize total circuit delay, which is comprised of gate delay and wire delay. Front-end software was initially developed when the gate delay, or the time it takes for an electrical signal to travel through a logic gate, was the most significant component of total circuit delay. Wire delay, or the time it takes for a signal to travel through a wire connecting two or more gates, was negligible and designers could use simple estimates and still meet targeted circuit speeds.
In the back-end implementation process, physical design software is used to transform the netlist generated by the front-end process into a physical layout of the chip. The resulting physical layout is usually output in a binary file format, commonly referred to as GDSII, that is used to generate the photomasks used to manufacture the integrated circuit. The two primary functions provided by traditional physical design software are placement
and routing. Placement determines the optimal physical location for the logic gates on the integrated circuit. After placement is completed, routing connects the logic gates with wires to achieve the desired circuit functionality. After the layout is completed, the final step in the back-end process is to run timing analysis to verify that the chip will run at the desired circuit speed. If circuit speeds are slower than the speeds reported by the synthesis software, the design must often be iterated back through the synthesis step in an attempt to improve the timing. Since each timing closure iteration cycle can take one or more weeks, successive iterations of the design process can significantly lengthen the time it takes to design and produce new chips.
Highly integrated, large integrated circuit (IC) designs require a fundamental new technology to create and maintain chip floorplans. Today, creating hierarchical chip floorplans is a manual error-prone task with less optimal quality of results in terms of chip die area and performance. Alternative flat chip design methodologies simplify floorplan creation but suffer from a long turn around time making it unacceptable.
Deep Submicron Challenges
The trend toward deep submicron technology has rendered traditionally separate front-end and back-end electronic design automation processes less effective for rapid, cost-effective and reliable chip designs. As integrated circuits have increased in complexity and feature sizes have dropped, the problems faced by chip designers have changed. Wire delay now accounts for the majority of total circuit delay and has become the most significant factor in circuit performance for deep submicron technologies. Front-end estimates of wire delay may vary considerably from actual wire delays measured in the final layout. As a result, the front-end timing might meet the design requirements, but the final layout timing at the completion of the back-end process may be unacceptable, requiring time-consuming iterations back through the front-end process.
Deep submicron process technologies bring additional complexities to the design and implementation process that can cause chip failures. These include signal integrity problems such as electrical interference from wires in close proximity, commonly referred to as crosstalk or noise, that can affect both circuit performance and functionality. Using existing design flows and software, designers must contend with analyzing and fixing these problems manually after the layout is completed. These adjustments often change the chip timing and further contribute to the timing closure problem.
These deep submicron challenges make it difficult to efficiently design chips using separate front-end and back-end processes. Semiconductor manufacturers and electronic products companies are currently seeking alternatives to older generation electronic design automation software to shorten design time, improve circuit speed, and handle larger chip designs. As a result, a significant opportunity exists for a new electronic design automation approach to chip design that can enable the design of more complex deep submicron integrated circuits, improve performance, and significantly reduce the time it takes to design and produce next-generation electronic products.
The important technical foundations for our software products are found within our unified data model architecture, platform logic synthesis, interconnect synthesis, automated chip creation, physical verification, design-for-manufacturability (DFM) and silicon signoff (known to us as our Signoff in the Loop flow), which allow our customers to reduce the number of iterations that are often required in conventional IC design processes.
Magmas fast, high-capacity logic synthesis provides a common front-end to all IC implementation platforms including programmable (FPGA), standard cell application specific integrated circuit (ASIC) and structured ASIC. A single RTL representation of the design is synthesized to technology-independent netlist and taken through architecture-specific mapping and physical synthesis to accurately predict the area, performance, power, testability and routability during physical implementation.
Unified Data Model Architecture
Conventional electronic design automation flows are typically based on a collection of software programs that have their own associated data models, often resulting in cumbersome design flows. We believe that we are the only electronic design automation vendor that offers a complete integrated circuit design implementation flow based on a unified data model. Our unified data model architecture is a key enabler for our ability to deliver automated signal integrity detection and correction, integrated power analysis and Signoff in the Loop. The unified data model contains all the logical and physical information about the design and is resident in core memory during execution. The various functional elements of our software such as the implementation engines for synthesis, placement and routing, and our analysis software for timing, RC and delay extraction, power, and signal integrity, all operate directly on this data model. Because the data model is concurrently available to all the engines and analysis software, it makes it possible to analyze the design and make rapid tradeoff decisions during the physical design process, thereby reducing design iterations.
Interconnect Synthesis is a recent addition to Magmas IC implementation design flow. With Interconnect Synthesis, optimization for timing, crosstalk, on-chip variation (OCV), power and yield are performed in the routing phase, rather than relying on logic optimization during logic synthesis as has historically been done. Optimization in logic synthesis alone was insufficient as wireload models started failing at 0.18 micron and below. At 90 nanometers and below, wire delay and the effect of their neighbors contribute to almost all deep-submicron effects. Accordingly, optimization has to be done as wires are assigned to tracks and are being routed. This move to combine optimization and routing requires a new flow with a new approachInterconnect Synthesis. We believe we are currently the only IC implementation vendor to enable the above-referenced advanced optimization techniques during the routing phase.
Automated Chip Creation
Automated chip creation is a new generation of implementation technology that automatically synthesizes chip floorplans. Automated chip creation is found in our new Talus family of products. Talus is an RTL to GDSII solution that aims to eliminate manual and resource intensive floorplan interventions. Designs are automatically partitioned into blocks, shaped and placed to achieve optimal floorplan chip area and performance. Furthermore, blocks are automatically distributed on multiple computing processing machines to implement any size designs 5-10 times faster. Talus allows prototyping of large designs early in the design cycle and flexible floorplans to implement engineering changes later in the design while it provides better quality of results.
Physical Verification and Design for Manufacturability
Every completed physical layout must be analyzed and manipulated before final manufacturing. This processcommonly called physical verificationhas increased in complexity and importance as manufacturing technology has moved from 130 nanometers to 90 nanometers, and now to 65 nanometers. Moreover, new physical phenomena at these manufacturing nodesincluding optical proximity correction (OPC) and chemical-mechanical-polishing (CMP) effectshave introduced the need for new design-for-manufacturing technologies.
Magma has introduced a new product line to address these challenges, with technologies resulting from Magmas acquisition of Mojave Design. This includes Quartz DRC and Quartz LVS, physical verification tools designed specifically to address the challenges at 90 nanometers and 65 nanometers. They are architected to do a full-chip design rule check for any design, at any node, in two hours or less. Quartz DRC and Quartz LVS have been architected to be highly scalable. By using techniques that enable fine-grain parallelism, Quartz DRC and Quartz LVS are able to use a large number (up to 100) separate Linux machines on a standard computer network. This ability to do distributed processing on a standard Linux machine provides the ability to linearly increase the speed of processingincreasing the number of processors by 2x increases the speed by 2xfor design rule checking. This scalability is essential to achieving a fast turnaround time of two hours or less.
Magma has a strong position for design for manufacturabilityas it offers both a leading physical design system, and also a leading physical verification system. Magma is leveraging the Mojave technology, and developing future products, including OPC-aware software, that will be used during both design and manufacturing.
Design teams have traditionally relied upon one set of tools for implementation and another set for signoff analysis. While this separation enables an advantageous tradeoff with respect to accuracy versus runtime, it also requires corrective iteration loops when discrepancies are found during signoff analysis. With the increased analysis challenges posed for analysis tools by 90- and 65-nanometer processes, such as combining noise analysis with on-chip variation, or OCV, across ever-increasing process corners and operating modes, the use of separate point signoff tools becomes a primary bottleneck in the drive to improve design cycle time. Magmas Signoff in the Loop flow breaks the signoff iteration bottleneck by making signoff-level analysis directly available during the implementation flow. The capabilities of Quartz RC are augmented by the integration of QuickCap technology into the extractor. QuickCap is the industry golden standard for reference parasitic extraction. The inclusion of this technology into a full-chip extractor enables users to attain the highest possible accuracy for the most timing critical nets on a chip.
Similar to the conventional design flow, our design flow starts by reading in technology libraries and constraint files. The following diagram illustrates our integrated design flow and where our products fit within this design flow.
Blast Create, first shipped in April 2003, is a key component of Magmas RTL-to-GDSII IC design solution. It enables logic designers to synthesize, visualize, evaluate and improve the quality of their RTL code, design constraints, testability requirements and floorplan. The physical netlist generated by Blast Create provides a clean handoff between RTL designer and layout engineer, eliminating back-to-front iterations necessary for timing closure in conventional flows.
Blast Fusion, first shipped in April 1999, is our physical design software that shortens the time it takes to design and produce deep submicron integrated circuits. The Blast Fusion flow starts by reading in the netlist, target library and design constraints. The netlist is optimized for circuit performance taking into account placement information that specifies the location of the gates in the chip layout. At the conclusion of this step, Blast Fusion generates a report that predicts the final timing performance that is achievable in the completed chip layout. In the final step, detailed physical design, Blast Fusion generates the final chip layout by performing the routing of wires that are needed to connect the gates into the desired circuit configuration and meet the timing performance requirements.
Blast Fusion is intended for use by chip design teams and other groups whose responsibility it is to take a design from netlist to completed chip layout. In the conventional ASIC design flow, front-end designers use synthesis software to translate and optimize their RTL files into a netlist that is then handed off to the ASIC or semiconductor vendor or separate layout design group for physical design using Blast Fusion. Sales of Blast Fusion account for the majority of our revenue.
Blast Noise®, first shipped in September 2000, is our noise detection and correction product. Interference, or noise from wires in close proximity to each other, can decrease chip performance or cause chip failure, particularly at 0.18 micron and below. Blast Noise works with Blast Fusion to actively detect potential noise problems and correct them during the physical design process.
Blast Plan, first shipped in September 2001, delivers hierarchical design planning capabilities for use in implementing complex integrated circuit and system-on-chip designs. In a hierarchical design methodology, a chip design is partitioned into blocks that are designed and implemented individually and then later assembled to create the entire chip. Blast Plan works with Blast Fusion and Blast Create to streamline the hierarchical planning and design of large chips and system-on-chips within a single environment.
Blast Plan Pro, first shipped in November 2002, combines the hierarchical design planning capabilities of Blast Plan with design exploration and early problem detection. Blast Plan Pro uses the same analysis engines as Magmas implementation system, thus providing a direct path to IC implementation using Blast Fusion.
Blast Rail, first shipped in May 2003, provides IC designers with integrated power analysis and planning, voltage-drop analysis, voltage-drop-induced delay analysis, and electromigration analysis on rail wires and vias. These features enable designers to maintain power integrity in their designs. Blast Rail is fully integrated with Magmas RTL-to-GDSII implementation flow to enable a correct-by-construction rail design solution. Blast Rail NX is our enhanced version of Blast Rail.
Blast Power, launched in May 2004, is the industrys first integrated power management and power minimization solution from RTL to GDSII. Blast Power is available as an option to Magmas Blast Create and Blast Fusion implementation system, enabling Magma to offer a low-power design methodology that includes embedded power, timing, and rail analysis and power minimization techniques. With Blast Power, Magma users will be able to make power-vs-timing and power-vs-area tradeoffs throughout the RTL-to-GDSII flowwithout having to export design data out of the Magma system. This tight integration of power optimization and management into the implementation process will enable users to deliver lower power and more cost-effective development cycles than point tool flows.
In June 2003 Magma acquired Aplus Design Technologies, Inc. (Aplus), a leader in physical synthesis and architecture analysis. Aplus products include PALACE, a physical synthesis tool for programmable devices (FPGAs), and ArchEvaluator, an architectural analysis tool. With the addition of these products to our product portfolio, we now offer implementation and physical design for cell-based, programmable and structured ASIC designs. Our customers are increasingly using structured ASIC designs, which enable a combination of cell-based and programmable logic, to reduce manufacturing costs.
PALACE, which first shipped in July 2001, is a fully automated physical synthesis tool for programmable logic devices. PALACE combines FPGA architecture-specific synthesis and mapping technologies with FPGA
physical layout using a unified single data model throughout the synthesis process. PALACE supports all the popular FPGA architectures from Xilinx, Altera, Actel, and QuickLogic and it closely interfaces with FPGA vendor physical design tools.
ArchEvaluator, which first shipped June 2000, is the only commercial EDA tool that enables the programmable or Structured ASIC architecture designers to discover new synthesis-friendly architectures with the best performance and density advantages. ArchEvaluator is able to evaluate a wide scope of architecture parameters.
Blast FPGA, made available in March 2005, is a unified RTL to FPGA tool that combines RTL synthesis technology from Blast Create and physical synthesis technology from PALACE within a single data model.
BLAST FPGA includes features such as an intuitive graphical user interface designed specific for FPGA designers, RTL and schematic views and cross probes, and embedded timing analysis. Blast FPGA also enables an easy FPGA migration to Structured ASIC or cell based ASIC within the same unified synthesis environment.
Blast Create SA, made available in December 2004, is a comprehensive front end design tool that enables synthesis, and partitioning of RTL description of the design into cell-based blocks and programmable blocks.
Similarly, Blast Fusion SA, made available in December 2004, is a complete physical design solution for programmable, cell-based or structured ASIC designs.
With the acquisition of Random Logic Corporation in October 2003, we acquired a capacitance extractor called QuickCap®, long considered the industrys leading parasitic extraction technology. QuickCap is a highly accurate 3D-field solver used in parameter extraction and rules generation, library cell extraction, critical cell analysis, and critical net analysis. QuickCap® NX, made available in February 2005, is an enhanced version of the QuickCap tool, targeted to address specific design challenges that occur in 90-nanometer and smaller process technologies.
Our acquisition of Silicon Metrics Corporation in October 2003, forming our Silicon Correlation Division, has allowed Magma to provide highly accurate models and characterization of various intellectual property (IP) blocks in nanometer designs. IP vendors, library developers, and COT design teams rely on software models to accurately represent the electrical behavior of circuits implemented with advanced process technologies. To meet the needs of these customers, Silicon Correlation Divisions SiliconSmart products provide robust timing, power, and signal integrity models in a variety of industry standard formats. When used with popular construction and verification tools, these models offer silicon predictability and designer productivity. As a result, SiliconSmart models help customers shorten design cycles and improve chip performance.
We continue to integrate into our design flow certain verification and design for manufacturability (DFM) technologies that we acquired by way of our April 2004 merger with Mojave, Inc. We expect our development efforts to result in an ability to design ICs that are more manufacturable, and with inherently better yield, than those designed by flows that do not incorporate DFM capability. Magma believes that by incorporating DFM into IC implementation, Magma will be well positioned to address the next generation of designs at 65 nanometers and below.
In addition to the above products, the Company has made available for general release (except where otherwise noted), from the Cobra development initiative, the following products described below:
Quartz RC: Provides signoff-quality parasitic extraction and can operate as either a standalone tool or integrated with the Blast Fusion system, where it underlies the Signoff in the Loop flow.
Quartz Time: Combines the proven static timer in Blast Fusion with advanced timing capabilities to create a standalone signoff timing system.
Blast Fusion® QT: Provides advanced capabilities that enable Signoff in the Loop timing analysis with concurrent optimization. This product provides designers access to a signoff timing analysis engine within the implementation flow, eliminating the need to iterate with external signoff tools.
Blast Fusion 5.0: Provides enhanced physical synthesis to improve congestion and timing of high performance designs. The product supports advanced 65nm routing rules and improved runtime up to 50%. The optimization engine will take full advantage of multi mode and margin less OCV analysis to reduce design margins and turn around time.
Quartz SSTA: Provides a parametric yield analysis capability for the design, providing parametric extraction and statistical timing analysis simultaneously.
Quartz DRC and Quartz LVS: Targeted to provide the fastest turnaround time of any physical verification tools, with a goal of performing full chip design rule check (DRC) in less than 2 hours.
Blast Plan FX: Provides automated hierarchical design capabilities for taking a complete hierarchical chip from RTL to GDSII in a deterministic, repeatable fashion throughout the design cycle.
Blast Yield: A comprehensive design-for-yield (DFY) solution it incorporates multiple techniques to optimize the design for parametric and functional yieldboth cell and wire yieldwithout compromising timing or area.
Quartz Formal: A logic equivalency checking tool used to verify the functional accuracy of a gate-level design with respect to its source HDL description.
Furthermore, we acquired the new product FineSim in connection with its acquisition of ACAD Corporation in November 2005. FineSim is the next generation highly accurate fast circuit simulator with full-chip analysis capabilities. These capabilities include advanced post-layout simulation features, high accuracy with low memory usage and high performance.
In addition, on April 17, 2006, we announced Talus, a new product line intended to offer improved automation and greater capacity in the design of integrated circuits. The initial Talus products, Talus LX and Talus PX, are in limited release and are expected to be generally available in September 2006 or soon thereafter.
We provide consulting and training to help our customers more rapidly adopt our technology. We also provide post-contract support, or maintenance, for our products.
We license our software products to semiconductor manufacturers and electronic products companies around the world. Our customers include Texas Instruments, Broadcom, Infineon, NEC, Nokia, Toshiba, IBM, Marvell, Renesas Technology and Vitesse. In fiscal 2006, Texas Instruments was our largest customer and accounted for 16% of our total revenue.
As of April 2, 2006, we had approximately $368 million in backlog, which we define as non-cancelable contractual commitments by our customers through purchase orders or contracts. Approximately 9% of the backlog is variable based on volume of usage of our products by the customers, approximately 2% includes specific future deliverables, and approximately 6% is recognized in revenue on a cash receipts basis. We have
estimated variable usage, for the purposes of determining our backlog, based on information from customers forecasts available at the contract execution date. It is possible that customers from whom we expect to derive revenue from backlog will default and as a result we may not be able to recognize expected revenue from backlog.
Revenue and Orders Mix
Our license revenue in any given quarter depends on the volume of short term licenses shipped during the quarter and the amount of long term, ratable and cash receipts revenue from deferred revenue that is recognized out of backlog and recognized on orders received during the quarter. We set our revenue targets for any given period based in part, upon an assumption that we will achieve a certain level of orders and a certain license mix of short term licenses. The precise mix of orders is subject to substantial fluctuation in any given quarter or multiple quarter periods, and the actual mix of licenses sold affects the revenue we recognize in the period. If we achieve the target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we deliver more long term or ratable licenses than expected) or may exceed them (if we deliver more short term licenses than expected).
Unbilled Accounts Receivable
Unbilled accounts receivable represent revenue that has been recognized in advance of contractual invoicing to the customer. We typically generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception. As of April 2, 2006 and March 31, 2005, unbilled accounts receivable were approximately $7.7 million and $14.1 million, respectively. These amounts were included in accounts receivable on our consolidated balance sheets for these periods.
Revenue by Geographic Areas
We generated 33% of our total revenue from sales outside the United States for fiscal 2006, compared to 43% in fiscal 2005. Additional disclosure regarding financial information on geographic areas is included in Note 11 of our Consolidated Financial Statements in Item 8 of this Annual Report.
Sales and Marketing
We license our products primarily through a direct sales force focused primarily on the industry leaders in the communications, computing, consumer electronics, networking and semiconductor industries. We have North American sales offices in California, Massachusetts, North Carolina, Pennsylvania, Texas, Washington and Canada. Internationally, we have European offices in Germany, France and the United Kingdom, an office in Israel and Asian offices in China, India, Japan, Korea and Taiwan. Our direct sales force is supported by a larger group of field application engineers that work closely with the customers technical chip design professionals.
As of April 2, 2006, we had 303 employees in our marketing, sales and technical sales support organizations. We intend to continue to expand our sales and field application engineering personnel on a worldwide basis.
The electronic design automation industry is highly competitive and characterized by technological change, evolving standards, and price erosion. Major competitive factors in the market we address include technical innovation, product features and performance, level of integration, reliability, price, total system cost, reduction in design cycle time, customer support and reputation.
We currently compete with companies that hold dominant shares in the electronic design automation market. In particular, Cadence Design Systems, Inc. and Synopsys, Inc. are continuing to broaden their product lines to provide an integrated design flow. Each of these companies has a longer operating history and
significantly greater financial, technical and marketing resources, as well as greater name recognition and larger installed customer bases than we do. These companies also have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships. Our competitors are better able to offer aggressive discounts on their products, a practice that they often employ. Our competitors offer a more comprehensive range of products than we do; for example, we do not offer logic simulation, full-feature custom layout editing, analog, or mixed signal products, which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors greater cash resources and higher market capitalization may give them a relative advantage over us in buying companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources. Further consolidation in the electronic design automation market could result in an increasingly competitive environment. Competitive pressures may prevent us from increasing market share or require us to reduce the price of products and services, which could harm our business. To execute our business strategy successfully, we must continue to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.
Also, a variety of small companies continue to emerge, developing and introducing new products. Any of these companies could become a significant competitor in the future. We also compete with the internal chip design automation development groups of our existing and potential customers. Therefore, these customers may not require, or may be reluctant to purchase, products offered by independent vendors.
Our competitors may develop or acquire new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new or additional products by competitors may cause potential customers to defer purchases of our products. If we fail to compete successfully, we will not gain market share and our business will fail.
Research and Development
We devote a substantial portion of our resources to developing new products and enhancing our existing products, conducting product testing and quality assurance testing, improving our core technology and strengthening our technological expertise in the electronic design automation market. Our research and development expenditures for fiscal 2006, 2005 and 2004 were $45.9 million, $41.7 million and $26.1 million, respectively. There have not been any customer-sponsored research activities since the inception of Magma.
As of April 2, 2006, our research and development group consisted of 252 employees. We have engineering centers in California and Texas in the United States, and in China, India, the Netherlands and Korea. Our engineers are focused in the areas of product development, advanced research, product engineering and design services. Our product development group develops our common core technology and is responsible for ensuring that each product fits into this common architecture. Our advanced research group works independently from our product development group to assess and develop new technologies to meet the evolving needs of integrated circuit design automation. Our product engineering group is primarily focused on product releases and customization. Our design services group is specifically focused on, and assists in completing, customer designs for commercial applications.
Currently, we hold, directly or indirectly, more than forty issued patents. Patent protection affords only limited protection for our technology. Our patents will expire on various dates between April 2018 and February 2024. We have filed, and plan to file, applications for additional patents. We do not know if our patent applications or any future patent application will result in a patent being issued with the scope of the claims we seek, if at all, or whether any patents we may receive will be challenged or invalidated. Rights that may be granted under our patent applications that may issue in the future may not provide us competitive advantages. Further, patent protection in foreign jurisdictions where we may need this protection may be limited or unavailable.
It is difficult to monitor unauthorized use of technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. In addition, our competitors may independently develop technology similar to ours. We will continue to assess appropriate occasions for seeking patent and other intellectual property protections for those aspects of our technology that we believe constitute innovations providing significant competitive advantages.
Our success depends in part upon our rights in proprietary software technology. We have patent applications pending for some of our proprietary software technology. We rely on a combination of copyright, trade secret, trademark and contractual protection to establish and protect our proprietary rights that are not protected by patents, and we enter into confidentiality agreements with those of our employees and consultants involved in product development. We routinely require our employees, customers and potential business partners to enter into confidentiality and nondisclosure agreements before we will disclose any sensitive aspects of our products, technology or business plans. We require employees to agree to surrender to us any proprietary information, inventions or other intellectual property they generate or come to possess while employed by us. Despite our efforts to protect our proprietary rights through confidentiality and license agreements, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. These precautions may not prevent misappropriation or infringement of our intellectual property.
Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. Many of our contracts contain provisions indemnifying our customers from third-party intellectual property infringement claims. On September 17, 2004 and again on September 26, 2005, Synopsys, Inc. filed suit for patent infringement against us (as further discussed below in Item 3 of this Part I), and, other parties may assert infringement claims against us and/or our customers. Our products may be found by a court to infringe issued patents that may relate to our products. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed that relate to our software products. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time consuming and could divert managements attention away from running our business. If there is a successful claim of infringement, we may be ordered to pay substantial monetary damages, we may be prevented from distributing some of our products, and/or we may be required to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all. Our failure to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.
As of April 2, 2006, we had 639 full-time employees, including 252 in research and development, 303 in sales and marketing and 84 in general and administrative. None of our employees are covered by collective bargaining agreements. We believe our relations with our employees are good.
We were incorporated in Delaware in 1997. Our principal executive offices are located at 5460 Bayfront Plaza, Santa Clara, California 95054, and our telephone number is (408) 565-7500. Our common stock is traded on the Nasdaq National Market under the ticker symbol LAVA. Our Web site address is www.magma-da.com. The information in our Web site is not incorporated by reference into this annual report. Through a link on the Investor Relations section of our Web site, we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. The public may read and copy any materials that we file with the SEC at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following Internet site: http://www.sec.gov. Our 2006 annual meeting will be held on August 29, 2006 at our offices in Santa Clara, California.
ITEM 1A. RISK FACTORS
Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations could suffer, and the trading price of our common stock could decline.
Our limited operating history makes it difficult to evaluate our business and prospects.
We were incorporated in April 1997 and introduced our first major software product, Blast Fusion, in April 1999. We have a limited history of generating revenue from our software products, and the revenue and income potential of our business and market is still unproven. As a result of our short operating history, we have limited financial data that can be used to evaluate our business. We have only been profitable in fiscal 2003 and fiscal 2004. Our software products represent a new approach to the challenges presented in the electronic design automation market, which to date has been dominated by established companies with longer operating histories. Key markets within the electronic design automation industry may fail to adopt our proprietary technologies and use our software products. Any evaluation of our business and our prospects must be considered in light of our limited operating history and the risks and uncertainties often encountered by relatively young companies.
We have a history of losses, except for fiscal 2003 and fiscal 2004, and had an accumulated deficit of approximately $136.6 million as of April 2, 2006; if we continue to incur losses, the trading price of our stock would be likely to decline.
We had an accumulated deficit of approximately $136.6 million as of April 2, 2006. Except for fiscal 2003 and fiscal 2004, we incurred losses in all other fiscal years. If we continue to incur losses, or if we fail to achieve profitability at levels expected by securities analysts or investors, the market price of our common stock is likely to decline. If we incur net losses, we may not be able to maintain or increase our number of employees or our investment in capital equipment, sales, marketing, and research and development programs, and we may not be able to continue to operate.
Our quarterly results are difficult to predict, and if we miss quarterly financial expectations, our stock price is likely to decline.
Our quarterly revenue and operating results fluctuate from quarter to quarter and are difficult to predict. It is likely that our operating results in some periods will be below investor expectations. If this happens, the market price of our common stock is likely to decline. Fluctuations in our future quarterly operating results may be caused by many factors, including:
We currently face lawsuits brought by Synopsys, Inc. related to patent infringement, and we may face additional intellectual property infringement claims or other litigation. Lawsuits can be costly to defend, can take the time of our management and employees away from day-to-day operations, and could result in our losing important rights and paying significant damages.
As described below, Synopsys, Inc. has filed various suits, including for patent infringement, against us (please see the discussion in Part I, Item 3, Legal Proceedings.) In addition, as described below, a putative shareholder class action lawsuit and a putative derivative lawsuit have been filed against us (please see the discussion in Part I, Item 3, Legal Proceedings.) Other related litigation may follow. In the future other parties may assert intellectual property infringement claims against us or our customers. We may have acquired or may in the future acquire software as a result of our acquisitions, and we could be subject to claims that such software infringes the intellectual property rights of third parties. In addition, we are often involved in or threatened with commercial litigation unrelated to intellectual property infringement claims such as labor litigation and contract claims, and we may acquire companies that are actively engaged in such litigation.
Our products may be found to infringe intellectual property rights of third parties, including third-party patents. In addition, many of our contracts contain provisions in which we agree to indemnify our customers from third-party intellectual property infringement claims that are brought against them based on their use of our products. Also, we may be unaware of filed patent applications that relate to our software products. We believe the patent portfolios of our competitors are far larger than ours, and this may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.
The outcome of intellectual property litigation, such as the pending Synopsys litigation (discussed herein) and other types of litigation, could be, in the case of intellectual property litigation, our loss of critical proprietary rights and, in the case of intellectual property litigation and other types of litigation, unexpected operating costs and substantial monetary damages. Intellectual property litigation and other types of litigation are expensive and time-consuming and could divert managements attention from our business. If there is a successful claim of infringement, we may be ordered to pay substantial monetary damages (including punitive damages), we may be prevented from distributing all or some of our products, and we may be required to develop non-infringing technology or enter into royalty or license agreements, which may not be available on acceptable terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business.
Publicly announced developments in our litigation matters may cause our stock price to decline sharply and suddenly. Other factors may reduce the market price of our common stock, and we are subject to ongoing risks of securities class action litigation related to volatility in the market price for our common stocks.
We may not be successful in defending some or all claims that may be brought against us. Regardless of the outcome, litigation can result in substantial expense and could divert the efforts of our management and technical personnel from our business. In addition, the ultimate resolution of the lawsuits could have a material adverse effect on our financial position, results of operations and cash flows and harm our ability to execute our business plan.
We may not be able to hire and/or retain the number of qualified personnel required for our business, particularly engineering personnel, which would harm the development and sales of our products and limit our ability to grow.
Competition in our industry for senior management, technical, sales, marketing and other key personnel is intense. If we are unable to retain our existing personnel, or attract and train additional qualified personnel, our growth may be limited due to a lack of capacity to develop and market our products.
In particular, we continue to experience difficulty in hiring and retaining skilled engineers with appropriate qualifications to support our growth strategy. Our success depends on our ability to identify, hire, train and retain qualified engineering personnel with experience in integrated circuit design. Specifically, we need to continue to attract and retain field application engineers to work with our direct sales force to technically qualify new sales opportunities and perform design work to demonstrate our products capabilities to customers during the benchmark evaluation process. Competition for qualified engineers is intense, particularly in Silicon Valley where our headquarters is located.
Retaining our employees has become more challenging due to the decline in our stock price over the past several years. Many of the stock options held by our employees may have an exercise price that is significantly higher than the current trading price of our stock, and these underwater options do not serve their purpose as incentives for our employees to remain with Magma. Although, as discussed below, we have attempted to address this problem in part via a stock option exchange program that allowed eligible employees to exchange existing underwater options for options exercisable for a smaller number of shares at the price of $9.20 per share, we cannot guarantee that this program will satisfy our employees. In addition, the increased volatility of our stock price due to the pendency of, and developments in, the Synopsys litigation and above-referenced shareholder litigation may affect employee morale. Furthermore, in light of our adopting SFAS 123R Share-Based Payment in the first quarter of our fiscal year 2007, we will be changing our employee compensation practices, and those changes could make it harder for us to retain existing employees and attract qualified candidates. If we lose the services of a significant number of our employees and/or if we cannot hire additional employees, we will be unable to increase our sales or implement or maintain our growth strategy.
Our success is highly dependent on the technical, sales, marketing and managerial contributions of key individuals, and we may be unable to recruit and retain these personnel.
We depend on our senior executives and certain key research and development and sales and marketing personnel, who are critical to our business. We do not have long-term employment agreements with our key employees, and we do not maintain any key person life insurance policies. Furthermore, our larger competitors may be able to offer more generous compensation packages to executives and key employees, and therefore we risk losing key personnel to those competitors. If we lose the services of any of our key personnel, our product development processes and sales efforts could be slowed. We may also incur increased operating expenses and be required to divert the attention of our senior executives to search for their replacements. The integration of our new executives or any new personnel could disrupt our ongoing operations.
Customer payment defaults may cause us to be unable to recognize revenue from backlog, and changes in the type of orders comprising backlog could affect the proportion of revenue recognized from backlog each quarter, which could have a material adverse effect on our financial condition and results of operations and on investor expectations.
A portion of our revenue backlog is variable based on volume of usage of our products by the customers or includes specific future deliverables or is recognized in revenue on a cash receipts basis. Management has
estimated variable usage based on customers forecasts, but there can be no assurance that these estimates will be realized. In addition, it is possible that customers from whom we expect to derive revenue from backlog will default and as a result we may not be able to recognize expected revenue from backlog. If a customer defaults and fails to pay amounts owed, or if the level of defaults increases, our bad debt expense is likely to increase. Any material payment default by our customers could have a material adverse effect on our financial condition and results of operations.
Our lengthy and unpredictable sales cycle, and the large size of some orders, makes it difficult for us to forecast revenue and increases the magnitude of quarterly fluctuations, which could harm our stock price.
Customers for our software products typically commit significant resources to evaluate available software. The complexity of our products requires us to spend substantial time and effort to assist potential customers in evaluating our software and in benchmarking it against our competition. As the complexity of the products we sell increases, we expect the sales cycle to lengthen. In addition, potential customers may be limited in their current spending by existing time-based licenses with their legacy vendors. In these cases, customers delay a significant new commitment to our software until the term of the existing license has expired. Also, because our products require a significant investment of time and cost by our customers, we must target those individuals within the customers organization who are able to make these decisions on behalf of their companies. These individuals tend to be senior management in an organization, typically at the vice president level. We may face difficulty identifying and establishing contact with such individuals. Even after initial acceptance, the negotiation and documentation processes can be lengthy. Our sales cycle typically ranges between three and nine months, but can be longer. Any delay in completing sales in a particular quarter could cause our operating results to fall below expectations. Furthermore, technological changes, litigation risk or other competitive factors could cause some customers to shorten the terms of deals significantly, and such shorter terms of deals could in turn have an impact on our total results for orders for this fiscal year.
We rely on a small number of customers for a significant portion of our revenue, and our revenue could decline due to delays of customer orders or the failure of existing customers to renew licenses or if we are unable to maintain or develop relationships with current or potential customers.
Our business depends on sales to a small number of customers. In fiscal 2006, we had one customer that accounted for more than 10% of our revenue, and our top three customers together accounted for approximately 29% of our revenue.
We expect that we will continue to depend upon a relatively small number of customers for a substantial portion of our revenue for the foreseeable future. If we fail to sell sufficient quantities of our products and services to one or more customers in any particular period, or if a large customer reduces purchases of our products or services, defers orders, or fails to renew licenses, our business and operating results could be harmed.
Most of our customers license our software under time-based licensing agreements, with terms that typically vary from 15 months to 48 months. Most of our license agreements automatically expire at the end of the term unless the customer renews the license with us or purchases a perpetual license. If our customers do not renew their licenses, we may not be able to maintain our current revenue or may not generate additional revenue. Some of our license agreements allow customers to terminate an agreement prior to its expiration under limited circumstancesfor example, if our products do not meet specified performance requirements or goals. If these agreements are terminated prior to expiration or we are unable to collect under these agreements, our revenue may decline.
Some contracts with extended payment terms provide for payments which are weighted toward the later part of the contract term. Accordingly, for bundled agreements, as the payment terms are extended, the revenue from these contracts is not recognized evenly over the contract term, but is recognized as the lesser of the cumulative amounts due and payable or ratably. For unbundled agreements, as the payment terms are extended, the revenue
from these contracts is recognized as amounts become due and payable. Revenue recognized under these arrangements will be higher in the later part of the contract term, which puts our revenue recognition in the future at greater risk of the customers continuing credit-worthiness. In addition, some of our customers have extended payment terms, which creates additional credit risk.
We compete against companies that hold a large share of the electronic design automation market and competition is increasing among EDA vendors as customers tightly control their EDA spending and use fewer vendors to meet their needs. If we cannot compete successfully, we will not gain market share and our revenue could decline.
We currently compete with companies that hold dominant shares in the electronic design automation market, such as Cadence and Synopsys. Each of these companies has a longer operating history and significantly greater financial, technical and marketing resources than we do, as well as greater name recognition and larger installed customer bases. Our competitors are better able to offer aggressive discounts on their products, a practice they often employ. Competition and corresponding pricing pressures among EDA vendors or other factors might be causing or might cause in the future the overall market for EDA products to have low growth rates, remain relatively flat or even decrease in terms of overall dollars. Our competitors offer a more comprehensive range of products than we do; for example, we do not offer logic simulation, full-feature custom layout editing, analog or mixed signal implementation products, which can sometimes be an impediment to our winning a particular customer order. In addition, our industry has traditionally viewed acquisitions as an effective strategy for growth in products and market share and our competitors greater cash resources and higher market capitalization may give them a relative advantage over us in buying companies with promising new chip design products or companies that may be too large for us to acquire without a strain on our resources.
Competition in the EDA Market has increased as customers rationalized their EDA spending by using products from fewer EDA vendors and continued consolidation in the electronic design automation market could intensify this trend. Also, many of our competitors, including Cadence and Synopsys, have established relationships with our current and potential customers and can devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships. Competitive pressures may prevent us from obtaining new customers and gaining market share, may require us to reduce the price of products and services or cause us to lose existing customers, which could harm our business. To execute our business strategy successfully, we must continue our efforts to increase our sales worldwide. If we fail to do so in a timely manner or at all, we may not be able to gain market share and our business and operating results could suffer.
Also, a variety of small companies continue to emerge, developing and introducing new products. Any of these companies could become a significant competitor in the future. We also compete with the internal chip design automation development groups of our existing and potential customers. Therefore, these customers may not require, or may be reluctant to purchase, products offered by independent vendors.
Our competitors may develop or acquire new products or technologies that have the potential to replace our existing or new product offerings. The introduction of these new or additional products by competitors may cause potential customers to defer purchases of our products. If we fail to compete successfully, we will not gain market share and our business may fail.
We may not be successful in integrating the operations of acquired companies and acquired technology.
We expect to continuously evaluate the possibility of accelerating our growth through acquisitions, as is customary in the electronic design automation industry. Achieving the anticipated benefits of past and possible future acquisitions will depend in part upon whether we can integrate the operations, products and technology of acquired companies with our operations, products and technology in a timely and cost-effective manner. The process of integrating with acquired companies and acquired technology is complex, expensive and time consuming, and may cause an interruption of, or loss of momentum in, the product development and sales activities and operations of both companies. In addition, the earnout arrangements we use, and expect to continue
to use, to consummate some of our acquisitions, pursuant to which we agreed to pay additional amounts of contingent consideration based on the achievement of certain revenue, bookings or product development milestones, can sometimes complicate integration efforts. We cannot be sure that any part or all of the integration will be accomplished on a timely basis, or at all. Assimilating previously acquired companies such as Silicon Metrics Corporation and Mojave, Inc., or any other companies we may seek to acquire in the future, involves a number of other risks, including, but not limited to:
Our operating results may be harmed if our customers do not adopt, or are slow to adopt, 65-nanometer design geometries.
Many Magma customers are currently working on 90-nanometer designs. Magma continues to work toward developing and enhancing its product line in anticipation of increased customer demand for 65-nanometer (sub-90 nanometer) design geometries. Similarly, Magma has acquired Mojave personnel and technology to better address customers needs for designing and verifying semiconductors that are manufacturable with higher yield and performance, which is a key design parameter when moving to 65-nanometer geometries. Notwithstanding our efforts to support 65-nanometer geometries, customers may fail to adopt or may be slower to adopt 65-nanometer geometries and we may be unable to convince our customers to purchase our related software products. Accordingly, any revenues we receive from enhancements to our products or acquired technologies may be less than the development or acquisition costs. If customers fail to adopt 65-nanometer design geometries or are slow to adopt 65-nanometer design geometries, our operating results may be harmed. In addition, if customers are not able successfully to make profits as they adopt smaller geometries, demand for our products may be adversely affected, and our operating results may be harmed.
Our operating results will be harmed if chip designers do not adopt Blast Fusion, Talus or products released under our Cobra initiative or our other current and future products.
Blast Fusion has accounted for a significant majority of our revenue since our inception and we believe that revenue from Blast Fusion, Talus and related products will account for most of our revenue for the foreseeable future. In addition, we have dedicated significant resources to developing and marketing Talus and products developed under our Cobra development initiative. We must gain market penetration of Blast Fusion, Talus and products released under our Cobra initiative in order to achieve our growth strategy and financial success. Moreover, if integrated circuit designers do not continue to adopt Blast Fusion or do not adopt Talus, our operating results will be significantly harmed. Furthermore, if there is a delay in the development or commercialization of Talus, our operating results may be significantly harmed.
We recently changed our organizational structure, and if this organizational structure does not successfully lead to effective interoperability between our products or effective collaboration among the applicable employees, then our operating results may be harmed.
We recently changed our organizational structure such that we now have major business units that are responsible for our various products. If this organizational structure does not successfully lead to effective interoperability between our products or effective collaboration among the applicable employees, then our operating results may be harmed. For example, if this organizational structure is not successful, we could experience delays in new product development that could cause us to lose customer orders, which could harm our operating results.
If the industries into which we sell our products experience recession or other cyclical effects affecting our customers research and development budgets, our revenue would be likely to decline.
Demand for our products is driven by new integrated circuit design projects. The demand from semiconductor and systems companies is uncertain and difficult to predict. Slower growth in the semiconductor and systems industries, a reduced number of design starts, reduction of electronic design automation budgets or continued consolidation among our customers would harm our business and financial condition.
The primary customers for our products are companies in the communications, computing, consumer electronics, networking and semiconductor industries. Any significant downturn in our customers markets or in general economic conditions that results in the cutback of research and development budgets or the delay of software purchases would likely result in lower demand for our products and services and could harm our business. For example, the United States economy, including the semiconductor industry, experienced a slowdown starting in 2000, which negatively impacted and may continue to impact our business and operating results. While the semiconductor industry experienced a moderate recovery in recent years, our customers have remained cautious, and it is not yet clear when increased R&D spending will occur. The continuing threat of terrorist attacks in the United States, the ongoing events in Iraq and other worldwide events including those in the Middle East have increased uncertainty in the United States economy. If the economy declines as a result of this economic, political and social turmoil, existing customers may delay their implementation of our software products and prospective customers may decide not to adopt our software products, either of which could negatively impact our business and operating results.
The electronics industry has historically been subject to seasonal and cyclical fluctuations in demand for its products, and this trend may continue in the future. These industry downturns have been, and may continue to be, characterized by diminished product demand, excess manufacturing capacity and subsequent erosion of average selling prices.
Difficulties in developing and achieving market acceptance of new products and delays in planned release dates of our software products and upgrades may harm our business.
To succeed, we will need to develop innovative new products. We may not have the financial resources necessary to fund all required future innovations. Expanding into new technologies or extending our product line into areas we have not previously addressed may be more costly or difficult than anticipated. Also, any revenue that we receive from enhancements or new generations of our proprietary software products may be less than the costs of development. If we fail to develop and market new products in a timely manner or if new products do not meet performance features as marketed, our reputation and our business will suffer.
Our costs of customer engagement and support are high, so our gross margin may decrease if we incur higher-than-expected costs associated with providing support services in the future or if we reduce our prices.
Because of the complexity of our products, we typically incur high field application engineering support costs to engage new customers and assist them in their evaluations of our products. If we fail to manage our
customer engagement and support costs, our operating results could suffer. In addition, our gross margin may decrease if we are unable to manage support costs associated with the services revenue we generate or if we reduce prices in response to competitive pressure.
Product defects could cause us to lose customers and revenue, or to incur unexpected expenses.
Our products depend on complex software, both internally developed and acquired or licensed from third parties. Our customers may use our products with other companies products, which also contain complex software. If our software does not meet our customers performance requirements or meet the performance features as marketed, our customer relationships may suffer. Also, a limited number of our contracts include specified ongoing performance criteria. If our products fail to meet these criteria, it may lead to termination of these agreements and loss of future revenue. Complex software often contains errors. Any failure or poor performance of our software or the third-party software with which it is integrated could result in:
Our product functions are often critical to our customers, especially because of the resources our customers expend on the design and fabrication of integrated circuits. Many of our licensing agreements contain provisions to provide a limited warranty, which provides the customer with a right of refund for the license fees if we are unable to correct errors reported during the warranty period. If our contractual limitations are unenforceable in a particular jurisdiction or if we are exposed to claims that are not covered by insurance, a successful claim could harm our business. We currently carry insurance coverage and limits that we believe are consistent with similarly situated companies within the EDA industry.
Much of our business is international, which exposes us to risks inherent to doing business internationally that could harm our business. We also intend to expand our international operations. If our revenue from this expansion does not exceed the expenses associated with this expansion, our business and operating results could suffer.
We generated 33% of our total revenue from sales outside North America for fiscal 2006, compared to 43% for fiscal 2005 and 48% for fiscal 2004. While most of our international sales to date have been denominated in U.S. dollars, our international operating expenses have been denominated in foreign currencies. As a result, a decrease in the value of the U.S. dollar relative to the foreign currencies could increase the relative costs of our overseas operations, which could reduce our operating margins.
The expansion of our international operations includes the maintenance of sales offices in Europe, the Middle East, and the Asia Pacific region. If our revenue from international operations does not exceed the expense of establishing and maintaining our international operations, our business could suffer. Additional risks we face in conducting business internationally include:
Future changes in accounting standards, specifically changes affecting revenue recognition, could cause adverse unexpected revenue fluctuations.
Future changes in accounting standards or interpretations thereof, specifically those changes affecting software revenue recognition, could require us to change our methods of revenue recognition. These changes could result in deferral of revenue recognized in current periods to subsequent periods or in accelerated recognition of deferred revenue to current periods, each of which could cause shortfalls in meeting the expectations of investors and securities analysts. Our stock price could decline as a result of any shortfall. Implementation of internal controls reporting and attestation requirements, as further described below, will impose additional financial and administrative obligations on us and will cause us to incur substantial implementation costs from third party consultants, which could adversely affect our results.
Changes in laws and regulations that affect the governance of public companies have increased our operating expenses and will continue to do so.
Recently enacted changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and the listing requirements for The Nasdaq Stock Market have imposed new duties on us and on our executives, directors, attorneys and independent registered public accounting firms. In order to comply with these new rules, we have hired additional personnel and use additional outside legal, accounting and advisory services, all of which have increased and may further increase our operating expenses over time. In particular, we have incurred and will continue to incur additional administrative expenses relating to the implementation of Section 404 of the Sarbanes-Oxley Act, which requires that we implement and maintain an effective system of internal controls and annual certification of our compliance by our independent auditor. For example, we have incurred significant expenses and will continue to incur expenses in connection with the implementation, documentation and continued testing of our internal control systems. Management time associated with these compliance efforts necessarily reduces time available for other operating activities, which could adversely affect operating results. For the years ended April 2, 2006 and March 31,2005, our independent registered public accounting firm certified that we were in compliance with the provision of Section 404 relating to effective internal control over financial reporting; however, our internal control obligations are ongoing and subject to continued review and testing. If we are unable to maintain full and timely compliance with these and other regulatory requirements, we could be required to incur additional costs, expend additional management time on remedial efforts and make related public disclosures that could adversely affect our stock price and result in securities litigation.
The effectiveness of disclosure controls is inherently limited.
We do not expect that our disclosure controls and procedures, or our internal control over financial reporting, will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system objectives will be met. The design of a control system must also reflect applicable resource constraints, and the benefits of controls must be considered relative to their costs. As a result of these inherent limitations, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Magma have been detected. Failure of the control systems to prevent error or fraud could materially adversely impact our financial results and our business.
Forecasting our tax rates is complex and subject to uncertainty.
Our management must make significant assumptions, judgments and estimates to determine our current provision for income taxes, deferred tax assets and liabilities, and any valuation allowance that may be recorded against our deferred tax assets. These assumptions, judgments and estimates are difficult to make due to their
complexity, and the relevant tax law is often changing. Our future effective tax rates could be adversely affected by the following:
Our success will depend on our ability to keep pace with the rapidly evolving technology standards of the semiconductor industry; if we are unable to keep pace, our products could be rendered obsolete, which would cause our operating results to decline.
The semiconductor industry has made significant technological advances. In particular, recent advances in deep sub-micron technology have required electronic design automation companies to continuously develop or acquire new products and enhance existing products. The evolving nature of our industry could render our existing products and services obsolete. Our success will depend, in part, on our ability to:
If we are unable, for technical, legal, financial or other reasons, to respond in a timely manner to changing market conditions or customer requirements, our business and operating results could be seriously harmed.
If we fail to offer and maintain competitive stock option packages for our employees, or if our stock price declines materially for a protracted period of time, we might have difficulty retaining our employees and our business may be harmed.
In todays competitive technology industry, employment decisions of highly skilled personnel are influenced by stock option packages, which offer incentives above traditional compensation only where there is a consistent, long-term upward trend over time of a companys stock price. Our stock price has declined significantly over the past several years due to market conditions and has recently been negatively affected by uncertainty surrounding the outcome of our patent litigation with Synopsys, Inc. (discussed below under Part I, Item 3, Legal Proceedings).
On June 22, 2005, our stockholders approved a stock option exchange program (Exchange Program) allowing non-executive employees holding options to purchase our common stock at exercise prices greater than or equal to $10.50 to exchange those options for a smaller number of new options at an exercise price equal to fair market value on the date of grant. Magma implemented this Exchange Program, and the date of grant was August 22, 2005, at which date the closing trading price of our stock was $9.20 per share. Therefore, the exercise price for new options under this Exchange Program is $9.20 per share. If this exercise price of $9.20 per share or the terms of the Exchange Program are not satisfactory to employees who participate in the Exchange Program, or, if our stock price remains below the grant price of $9.20, our ability to retain employees could be affected.
Many of the options held by our non-executive employees, including options issued in the Exchange Program, have an exercise price significantly above the current trading price of our stock; on April 2, 2006 approximately 78% of the options held by our non-executive employees were underwater.
If our stock price continues to decline in the future due to market conditions, investors perceptions of the technology industry or managerial or performance problems we have, we may be forced to grant additional options to retain employees. This in turn could result in:
In addition, the new accounting requirements for employee stock options discussed below may adversely affect our option grant practices and our ability to recruit and retain employees.
Due to changes in the accounting treatment for employee stock options, we are changing our employee compensation practices, and our reported results of operations will likely be adversely affected.
As of April 2, 2006, we accounted for the issuance of employee stock options under principles that do not require us to record compensation expense for options granted at fair market value. In December 2004, the FASB issued SFAS 123R, Share-Based Payment, which eliminates the ability to account for share-based compensation transactions using APB 25, and generally requires instead that such transactions be accounted for using a fair-value based method. Under SFAS 123R, companies are required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. We are required to adopt the new rules in the first quarter of our fiscal year 2007. This change in accounting treatment will result in significant additional compensation expense compared to prior periods and will likely adversely affect our reported results of operations and hinder our ability to achieve profitability. We are continuing to assess the full impact of the adoption of SFAS 123R on our business practices and, as part of that assessment, are changing our employee compensation practices. These changes could make it harder for us to retain existing employees and attract qualified candidates.
If our sales force compensation arrangements are not designed effectively, we may lose sales personnel and resources.
Designing an effective incentive compensation structure for our sales force is critical to our success. We have experimented, and continue to experiment, with different systems of sales force compensation. If our incentives are not well designed, we may experience reduced revenue generation, and we may also lose the services of our more productive sales personnel, either of which would reduce our revenue or potential revenue.
Fluctuations in our growth place a strain on our management systems and resources, and if we fail to manage the pace of our growth, our business could be harmed.
Periods of growth followed by efforts to realign costs when revenue growth is slower than anticipated have placed a strain on our management, administrative and financial resources. For example, in fiscal year 2005 we decreased our workforce by 23 employees. Over time we have significantly expanded our operations in the United States and internationally, and we plan to continue to expand the geographic scope of our operations. To pace the growth of our operations with the growth in our revenue, we must continue to improve administrative, financial and operations systems, procedures and controls. Failure to improve our internal procedures and controls could hinder our efforts to adequately manage our growth, disrupt operations, lead to deficiencies in our internal controls and financial reporting and ultimately harm our business.
If chip designers and manufacturers do not integrate our software into existing design flows, or if other software companies do not cooperate in working with us to interface our products with their design flows, demand for our products may decrease.
To implement our business strategy successfully, we must provide products that interface with the software of other electronic design automation software companies. Our competitors may not support our or our customers efforts to integrate our products into their existing design flows. We must develop cooperative relationships with competitors so that they will work with us to integrate our software into customers design flow. Currently, our software is designed to interface with the existing software of Cadence, Synopsys and others. If we are unable to convince customers to adopt our software products instead of those of competitors offering a broader set of products, or if we are unable to convince other software companies to work with us to interface our software with theirs to meet the demands of chip designers and manufacturers, our business and operating results will suffer.
We may not obtain sufficient patent protection, which could harm our competitive position and increase our expenses.
Our success and ability to compete depends to a significant degree upon the protection of our software and other proprietary technology. We currently have a number of issued patents in the United States, but this number is relatively few in relation to our competitors.
These legal protections afford only limited protection for our technology. In addition, rights that may be granted under any patent application that may issue in the future may not provide competitive advantages to us. Further, patent protection in foreign jurisdictions where we may need this protection may be limited or unavailable. It is possible that:
We believe the patent portfolios of our competitors are far larger than ours, and this may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses.
We rely on trademark, copyright and trade secret laws and contractual restrictions to protect our proprietary rights, and if these rights are not sufficiently protected, it could harm our ability to compete and generate income.
To establish and protect our proprietary rights, we rely on a combination of trademark, copyright and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses. Our ability to compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to agreements, which impose certain restrictions on the licensees ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Our proprietary rights may not be adequately protected because:
The laws of some countries in which we market our products may offer little or no protection of our proprietary technologies. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for it, which would harm our competitive position and market share.
Our directors, executive officers and principal stockholders own a substantial portion of our common stock and this concentration of ownership may allow them to elect most of our directors and could delay or prevent a change in control of Magma.
Our directors, executive officers and stockholders who currently own over 5% of our common stock beneficially own a substantial portion of our outstanding common stock. These stockholders, in a combined vote, will be able to significantly influence all matters requiring stockholder approval. For example, they may be able to elect most of our directors, delay or prevent a transaction in which stockholders might receive a premium over the market price for their shares or prevent changes in control or management.
We may need additional capital in the future, but there is no assurance that funds would be available on acceptable terms.
In the future we may need to raise additional capital in order to achieve growth or other business objectives. This financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing stockholders. If adequate funds are not available or are not available on acceptable terms, our ability to expand, develop or enhance services or products, or respond to competitive pressures would be limited.
Our certificate of incorporation, bylaws and Delaware corporate law contain anti-takeover provisions which could delay or prevent a change in control even if the change in control would be beneficial to our stockholders. We could also adopt a stockholder rights plan, which could also delay or prevent a change in control.
Delaware law, as well as our certificate of incorporation and bylaws, contain anti-takeover provisions that could delay or prevent a change in control of our company, even if the change of control would be beneficial to the stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These anti-takeover provisions:
In addition, Section 203 of the Delaware General Corporation Law and the terms of our stock option plans may discourage, delay or prevent a change in control of our company. That section generally prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder. Also, our stock option plans include change-in-control provisions that allow us to grant options or stock purchase rights that will become vested immediately upon a change in control of us.
The board of directors also has the power to adopt a stockholder rights plan, which could delay or prevent a change in control even if the change in control appeared to be beneficial to stockholders. These plans, sometimes called poison pills, are sometimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If the board were to adopt such a plan it might have the effect of reducing the price that new investors are willing to pay for shares of our common stock.
We are subject to risks associated with changes in foreign currency exchange rates.
We transact some portions of our business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to operating expenses in the United Kingdom, Europe and Japan, which are denominated in the respective local currencies. As of April 2, 2006, we had no hedging contracts outstanding. We do not currently use financial instruments to hedge operating expenses denominated in Euro, British Pounds and Japanese Yen. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
The convertible notes we issued in May 2003 are debt obligations that must be repaid in cash in May 2008 if they are not converted into our common stock at an earlier date, which is unlikely to occur if the price of our common stock does not exceed the conversion price.
In May 2003, we issued $150.0 million principal amount of zero coupon convertible notes due May 2008. In May 2005, we repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7 percent of the total) of these notes at an average discount to face value of approximately 22 percent. In addition, in May 2006, we repurchased another $40.3 million face amount (approximately 38.2 percent of the remaining principal) of these notes at an average discount to face value of approximately 13 percent. Magma spent an aggregate of approximately $34.8 million and $35.0 million, respectively, on the repurchases in May 2005 and May 2006. The repurchases leave approximately $65.2 million aggregate principal amount of convertible subordinated notes outstanding. We will be required to repay that principal amount in full in May 2008 unless the holders of those notes elect to convert them into our common stock before the repayment date. The conversion price of the notes is $22.86 per share. If the price of our common stock does not rise above that level, conversion of the notes is unlikely and we would be required to repay the principal amount of the notes in cash. There have been previous quarters in which we have experienced shortfalls in revenue and earnings from levels expected by securities analysts and investors, which have had an immediate and significant adverse effect on the trading price of our common stock. In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations may adversely affect the price of our stock, regardless of our operating performance. Because the notes are convertible into shares of our common stock, volatility or depressed prices for our common stock could have a similar effect on the trading price of the notes.
Hedging transactions and other transactions may affect the value of our common stock and our convertible notes.
We entered into hedging arrangements with Credit Suisse First Boston International at the time we issued our convertible notes, with the objective of reducing the potential dilutive effect of issuing common stock upon conversion of the notes. At the time of our May 2005 and May 2006 repurchases of our zero coupon convertible notes, portions of the hedging arrangements were retired. These hedging arrangements are likely to have caused
Credit Suisse First Boston International and others to take positions in our common stock in secondary market transactions or to enter into derivative transactions at or after the sale of the notes. Any market participants entering into hedging arrangements are likely to modify their hedge positions from time to time prior to conversion or maturity of the notes by purchasing and selling shares of our common stock or other securities, which may increase the volatility and reduce the market price of our common stock.
We may be unable to meet the requirements under the indenture to purchase our convertible notes upon a change in control.
Upon a change in control, which is defined in the indenture to include some cash acquisitions and private company mergers, note holders may require us to purchase all or a portion of the notes they hold. If a change in control were to occur, we might not have enough funds to pay the purchase price for all tendered notes. Future credit agreements or other agreements relating to our indebtedness might prohibit the redemption or repurchase of the notes and provide that a change in control constitutes an event of default. If a change in control occurs at a time when we are prohibited from purchasing the notes, we could seek the consent of our lenders to purchase the notes or could attempt to refinance this debt. If we do not obtain a consent, we could not purchase the notes. Our failure to purchase tendered notes would constitute an event of default under the indenture, which might constitute a default under the terms of our other debt. In such circumstances, or if a change in control would constitute an event of default under our senior indebtedness, the subordination provisions of the indenture would possibly limit or prohibit payments to note holders. Our obligation to offer to purchase the notes upon a change in control would not necessarily afford note holders protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving us.
Failure to obtain export licenses could harm our business by preventing us from transferring our technology outside of the United States.
We are required to comply with U.S. Department of Commerce regulations when shipping our software products and/or transferring our technology outside of the United States or to certain foreign nationals. We believe we have complied with applicable export regulations, however, these regulations are subject to change, and, future difficulties in obtaining export licenses for current, future developed and acquired products and technology could harm our business, financial conditions and operating results.
Our business operations may be adversely affected in the event of an earthquake or other natural disaster.
Our corporate headquarters and much of our research and development operations are located in Silicon Valley, California, which is an area known for its seismic activity. An earthquake, fire or other significant natural disaster could have a material adverse impact on our business, financial condition and/or operating results.
ITEM 2. PROPERTIES.
Our corporate headquarters are located in Santa Clara, California, where we occupy approximately 130,000 square feet under a lease expiring on July 31, 2010. We have North American sales offices in California, Massachusetts, North Carolina, Pennsylvania, Texas, Washington and Canada. Internationally, we have European offices in Germany, the Netherlands, France and the United Kingdom, an office in Israel, and Asian offices in China, India, Japan, Korea and Taiwan. We believe our current facilities are adequate to support our current and near-term operations. However, if we need additional space, adequate space may not be available on commercially reasonable terms or at all.
ITEM 3. LEGAL PROCEEDINGS
Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. C04-03923, United States District Court, Northern District of California. In this action, filed September 17, 2004, Synopsys has sued Magma for alleged infringement of U.S. Patent Nos. 6,378,114 (the 114 Patent), 6,453,446 (the 446 Patent), and 6,725,438 (the 438 Patent). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by us as a result of our alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Quarterly Reports on Form 10-Q for the three months ended October 2, 2005, for the three months ended July 3, 2005, and for the three months ended January 1, 2006.
On October 21, 2004, we filed our answer and counterclaims (Answer) to the Complaint. On November 10, 2004, Synopsys filed motions to strike and dismiss certain affirmative defenses and counterclaims in the Answer. On November 24, 2004 we filed an Amended Answer and Counterclaims (Amended Answer). By order dated November 29, 2004, the Court denied Synopsys motions as moot in light of the Amended Answer. On December 10, 2004, Synopsys moved to strike and dismiss certain affirmative defenses and counterclaims in the Amended Answer. By order dated January 20, 2005, the Court denied in part and granted in part Synopsys motion. In its pretrial preparation order dated January 21, 2005, the Court set forth a schedule for the case which, among other things, sets trial for April 24, 2006.
On February 3, 2005, Synopsys filed its Reply to the Amended Answer. On March 17, 2005, Synopsys filed a First Amended Complaint, which asserts seven causes of action against us and/or Lukas van Ginneken: (1) patent infringement (against both defendants), (2) breach of contract (against van Ginneken), (3) inducing breach of contract (against Magma), (4) fraud (against Magma), (5) conversion (against both defendants), (6) unjust enrichment/constructive trust (against both defendants), and (7) unfair competition (against both defendants). Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by us as a result of our alleged exploitation of the alleged inventions in the patents-in-suit. On April 1, 2005, we filed a motion to dismiss the third through seventh causes of action. This motion was granted in part and denied in part by order dated May 18, 2005.
On April 11, 2005, Synopsys voluntarily dismissed van Ginneken from the lawsuit without prejudice. Also on April 11, 2005, Synopsys filed against us a motion for partial summary judgment establishing unfair competition and a motion for partial summary judgment based on the doctrine of assignor estoppel.
On June 7, 2005, Synopsys filed a Second Amended Complaint that asserts six causes of action against us: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by us as a result of our alleged exploitation of the alleged inventions in the patents-in-suit. On June 10, 2005, Magma moved for summary judgment as to the second through sixth causes of action in the Second Amended Complaint based on the applicable statutes of limitations. On June 21, 2005, we moved to dismiss the third cause of action alleging fraud in the Second Amended Complaint and moved to strike certain allegations in the Second Amended Complaint. The Court granted our motion to dismiss and strike by order dated July 15, 2005.
On July 1, 2005, the Court granted Synopsyss motion for partial summary judgment regarding assignor estoppel, dismissing Magmas affirmative defenses and counterclaim alleging the invalidity of the 114 Patent. On July 14, 2005, the Court vacated the hearings on Magmas motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint and Synopsyss motion for partial summary judgment establishing unfair competition. The Court stated that it would reset the motions for hearing, if necessary, after the claims construction hearing scheduled for August 15, 2005.
On July 29, 2005, Synopsys moved to preliminarily enjoin Magma from abandoning or dedicating to the public the 446 Patent or the 438 Patent. Also on July 29, 2005, Synopsys moved for partial summary judgment seeking dismissal of certain counterclaims and defenses asserted by us on the grounds of estoppel by contract. On September 16, 2005, Synopsys filed a revised motion for preliminary injunction. On September 30, 2005, we filed our oppositions to Synopsyss preliminary injunction motion and estoppel by contract motion.
On August 3, 2005, Synopsys filed a Third Amended Complaint that asserts six causes of action against us: (1) patent infringement, (2) inducing breach of contract/interference with contractual relations, (3) fraud, (4) conversion, (5) unjust enrichment/constructive trust/quasi-contract, and (6) unfair competition. Synopsys seeks injunctive relief, declaratory relief, at least $100 million in damages, trebling of damages, punitive damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by us as a result of our alleged exploitation of the alleged inventions in the patents-in-suit.
On August 30, 2005, the Court issued a temporary restraining order against us restraining and enjoining us from taking any steps in the United States Patent and Trademark Office to abandon, suspend or disclaim the 446 and 438 Patents, failing or refusing to pay the maintenance fees for the 446 and 438 Patents, or seeking reexamination of the 446 and 438 Patents. The temporary restraining order was scheduled to remain in effect until the hearing on Synopsyss motion for a preliminary injunction that was scheduled for December 2, 2005. On December 1, 2005, the Court, vacated the hearing and granted Synopsyss motion for preliminary injunction. The Court entered the preliminary injunction enjoining us from abandoning, dedicating to the public or seeking reexamination in the United States Patent and Trademark Office of the 446 Patent or the 438 Patent.
On September 2, 2005, we filed an Answer and Counterclaims to Synopsyss Third Amended Complaint. In that pleading, Magma alleges, inter alia, that IBM is a joint owner of the patents-in-suit and that, as a result, we cannot be liable for infringement because (1) Synopsys lacks standing to assert the patents-in-suit against Magma, and (2) IBM has granted Magma a license under the patents-in-suit.
On October 14, 2005, the Court granted Synopsyss request for permission to file an amended opposition to Magmas motion for summary judgment on the second through sixth causes of action in the Second Amended Complaint. Synopsys filed its amended opposition on December 20, 2005, and we filed our reply on January 13, 2006. The motion was set for hearing on January 27, 2006, but the Court vacated the hearing date and took the matter under submission.
On October 19, 2005, the Court granted in part and denied in part Synopsyss motion to strike certain affirmative defenses and to dismiss certain counterclaims in our Answer and Counterclaims to Synopsyss Third Amended Complaint. The Court dismissed without leave to amend our counterclaims seeking correction of inventorship of the 446 and 438 Patents. The Court also struck without leave to amend our affirmative defenses of (1) invalidity of the 446 and 438 Patents based on failure to name all inventors, (2) unenforceability of the 446 and 438 patents due to inequitable conduct, and (3) unclean hands. The Court struck with leave to amend our affirmative defenses of invalidity of the 446 and 438 Patents based on 35 U.S.C. §§ 102, 103 and 112, as well as our affirmative defense that Synopsys is not the owner of any invention defined by the claims of the 446 and 438 Patents. On October 24, 2005, we filed a motion for summary judgment as to the first cause of action (for patent infringement) in Synopsyss Third Amended Complaint on the grounds that IBM is an owner of all the patents-in-suit. Also on October 24, 2005, Synopsys filed (1) a motion for partial summary judgment to dismiss our joint ownership defenses and counterclaims, and (2) a motion for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel.
On November 2, 2005, we filed a motion for leave to file an amended answer and counterclaims to Synopsyss Third Amended Complaint, requesting leave to amend our answer to add affirmative defenses of invalidity of the 446 and 438 Patents based on 35 U.S.C. §§ 102, 103 and 112. Our motion was set for hearing on December 16, 2005, but the Court vacated the hearing date and took the matter under submission.
On November 8, 2005, Synopsys filed a motion for sanctions against us based on our assertion of non-infringement defenses and counterclaims in the litigation. We opposed the motion, which was set for hearing on December 16, 2005. The hearing was vacated and the motion was taken under submission by the Court.
On November 8, 2005, we filed a motion seeking leave to file a motion for reconsideration of the Courts October 19, 2005 Order striking certain of our defenses without leave to amend. The Court granted our request on November 21, 2005. On December 9, 2005, we filed a motion for reconsideration of the Courts October 19, 2005 Order striking our affirmative defense of unclean hands and for leave to amend our answer to assert an unclean hands defense. The motion was set for hearing on January 13, 2006, but the Court vacated the hearing and took the matter under submission.
On December 23, 2005, Synopsys filed a motion for partial summary judgment regarding our statute of limitations defense. We opposed the motion, which was set for hearing on January 27, 2006. The hearing was vacated and the motion taken under submission by the Court.
On December 29, 2005, we filed a notice of interlocutory appeal to the Court of Appeals for the Federal Circuit of the Courts December 1, 2005, preliminary injunction against us. By agreement of the parties, Magma has dismissed the appeal.
On January 20, 2006, we filed a motion to bifurcate the trial into issues of patent ownership and all other issues. The parties subsequently stipulated to bifurcate the case with patent ownership to be tried first.
Fact and expert discovery relating to patent ownership have closed. By stipulation so-ordered on March 13, 2006, the parties have agreed to schedule any remaining discovery after the patent ownership trial is resolved.
By order dated March 30, 2006, the Court denied Magmas motion for summary judgment regarding patent ownership, as well Synopsyss motions (1) for partial summary judgment based on estoppel by contract, (2) for partial summary judgment to dismiss our joint ownership defenses and counterclaims, and (3) for partial summary judgment to dismiss allegations of co-ownership based on judicial and quasi-estoppel. The parties subsequently stipulated (a) that we would withdraw our claim to ownership of the 446 and 438 Patents on the basis that the buckets claims (i.e., Claims 17, 18, 31, and 32 of the 446 Patent and Claims 17 and 18 of the 438 Patent) were conceived by Magma engineers after Lukas van Ginneken left Synopsys and (b) that Synopsys would withdraw its assertion that Magma would be foreclosed from arguing that the inventions in the 446 and 438 Patents were reduced to practice after van Ginneken left Synopsys.
The ownership case was tried to the Court, without a jury, from April 24, 2006 through May 10, 2006. The parties opening post-trial briefs and findings of fact and conclusions of law were filed on June 9, 2006. The parties reply post-trial briefs are due June 30, 2006.
On April 18, 2005, Synopsys, Inc. filed an action against us in Germany at the Landgericht München I (District Court in Munich) seeking to obtain ownership of the European patent application corresponding to Magmas 446 Patent. The action has been stayed pending the outcome of the above-referenced Synopsys action filed in the United States. This action was also discussed in our Quarterly Reports on Form 10-Q for the three months ended July 3, 2005, October 2, 2005 and January 1, 2006.
On July 29, 2005, Synopsys, Inc. filed an action against us in Japan in Civil Department No. 40 of the Tokyo District Court seeking to obtain ownership of the Japanese patent application corresponding to Magmas 446 Patent. We have engaged counsel in Japan and will seek to stay this action pending the outcome of the above-referenced Synopsys action filed in the United States. The Japanese Court held a hearing on January 18, 2006 and set a further hearing on March 6, 2006. This action was also discussed in our Quarterly Reports on Form 10-Q for the three months ended July 3, 2005, October 2, 2005 and January 1, 2006. The action is currently on hold.
We intend to vigorously defend against the claims asserted by Synopsys and to fully enforce our rights against Synopsys. However, the results of any litigation are inherently uncertain and we can not assure that it will be able to successfully defend against the Complaint. A favorable outcome for Synopsys could have a material adverse effect on our financial position, results of operations or cash flows. We are currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to Synopsys.
On June 13, 2005, a putative shareholder class action lawsuit captioned The Cornelia I. Crowell GST Trust vs. Magma Design Automation, Inc., Rajeev Madhavan, Gregory C. Walker and Roy E. Jewell., No. C 05 02394, was filed in U.S. District Court, Northern District of California. The complaint alleges that defendants failed to disclose information regarding the risk of Magma infringing intellectual property rights of Synopsys, Inc., in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and prays for unspecified damages. Defendants have moved to dismiss the complaint. This lawsuit was also discussed in our Quarterly Reports on Form 10-Q for the three months ended July 3, 2005, October 2, 2005 and January 1, 2006.
On July 26, 2005, a putative derivative complaint captioned Susan Willis v. Magma Design Automation, Inc. et al., No. 1-05-CV-045834, was filed in the Superior Court of the State of California for the County of Santa Clara. The Complaint seeks unspecified damages purportedly on behalf of Magma for alleged breaches of fiduciary duties by various directors and officers, as well as for alleged violations of insider trading laws by executives during a period between October 23, 2002 and April 12, 2005. Defendants have demurred to the Complaint, and the action has been stayed pending further developments in the putative shareholder class action referenced above. This lawsuit was also discussed in our Quarterly Reports on Form 10-Q for the three months ended July 3, 2005, October 2, 2005 and January 1, 2006.
On September 26, 2005, Synopsys, Inc. filed an action against Magma in the Superior Court of the State of California in and for the County of Santa Clara, entitled Synopsys, Inc. v. Magma Design Automation, Inc., et al., Case Number 105 CV 049638. Synopsys alleges that Magma committed unfair business practices by asserting defenses of non-infringement and invalidity to patent infringement allegations brought by Synopsys in the patent infringement action already pending against Magma in the Northern District of California. The Complaint seeks unspecified monetary damages, an unspecified restitutionary/disgorgement award, injunctive relief, fees and costs, and an accounting of all revenues and profits derived from licensing the technology at issue. On October 19, 2005, we removed the action to the United States District Court for the Northern District of California. On October 26, 2005, we moved to strike and dismiss the complaint. On October 27, 2005, the Court granted our motion to relate the removed action with the preexisting patent infringement action, and both actions are now assigned to Judge Maxine M. Chesney. The Court vacated the hearing on our motion to strike and dismiss the complaint and has taken the matter under submission. This action was also discussed in our Quarterly Reports on Form 10-Q for the three months ended October 2, 2005 and January 1, 2006.
On September 26, 2005, Synopsys, Inc. filed an action against Magma in Delaware federal court, Synopsys, Inc. v. Magma Design Automation, Inc., Civil Action No. 05-701. The Complaint alleges infringement of U.S. Patent Nos. 6,434,733 (the 733 Patent), 6,766,501 (the 501 Patent), and 6,192,508 (the 508 Patent). The patents-in-suit relate to methods for designing integrated circuits. The Complaint seeks unspecified monetary damages, injunctive relief, trebling of damages, fees and costs, and the imposition of a constructive trust for the benefit of Synopsys over any profits, revenues or other benefits allegedly obtained by us as a result of our alleged infringement of the patents-in-suit. In addition to the below discussion, this case was also discussed in our Quarterly Reports on Form 10-Q for the three months ended October 2, 2005 and January 1, 2006.
On October 19, 2005, we filed our answer and counterclaims (Answer) to Synopsyss Complaint. The Answer asserts that our products do not infringe the patents-in-suit, that the patents-in-suit are unenforceable, and that the 733 Patent and the 501 Patent were fraudulently obtained by Synopsys and are therefore unenforceable. The Answer also asserts antitrust counterclaims based on Synopsyss assertion of the 733 and 501 Patents, as well as claims for product disparagement and trade libel, statutory and common law unfair competition, and tortuous interference with business relations. The counterclaims seek treble damages and other equitable relief for Synopsyss anticompetitive and tortuous conduct.
On October 25, 2005, we filed an Amended Answer, adding a counterclaim for infringement of U.S. Patent No. 6,505,328 (the 328 Patent). The 328 Patent relates to methods for designing integrated circuits. We seek treble damages and an injunction against Synopsys for the sale and manufacture of products we allege infringe the 328 Patent.
On November 22, 2005, Synopsys filed a motion to dismiss Magmas antitrust and other commercial counterclaims. We opposed that motion on December 7, 2005. Synopsys filed its reply brief on December 14, 2005. The Court denied Synopsyss motion on May 25, 2006.
On January 9, 2006, Synopsys filed a request for the United States Patent and Trademark Office to reexamine its 733 and 501 Patents in light of two prior art references that it had not previously disclosed to the Patent Office. On January 23, 2006, Synopsys filed a motion with the Delaware federal court to bifurcate and stay its claims for infringement of its 733 and 501 Patents and Magmas counterclaims except for its claim for infringement of the 328 Patent, based in part on Synopsyss having filed the request for patent reexamination. Our opposition to that motion was filed on February 6, 2006. The Court denied Synopsyss motion on May 25, 2006.
On March 24, 2006, we filed a motion for leave to file a Second Amended Answer and Counterclaims, which would add counterclaims for infringement of U.S. Patent Nos. 6,519,745 (the 745 Patent), 6,931,610 (the 610 Patent), 6,854,093 (the 093 Patent), and 6,857,116 (the 116 Patent). All four patents relate to methods for designing integrated circuits. Synopsys opposed the motion on April 7, 2006. We filed our reply brief on April 14, 2006. The Court granted our motion on May 25, 2006.
Fact discovery is ongoing and is currently scheduled to close on September 29, 2006, and trial is currently scheduled for June of 2007.
In addition to the above, from time to time, we are involved in disputes that arise in the ordinary course of business. The number and significance of these disputes is increasing as our business expands and it grows larger. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these disputes could harm our business, financial condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G(3) of Form 10-K, the information regarding our executive officers required by Item 401(b) of Regulation S-K is listed below.
The following table provides the names, offices, and ages of each of our executive officers as of May 31, 2006:
Rajeev Madhavan has served as our Chief Executive Officer and Chairman of the Board of Directors since our inception in April 1997. Mr. Madhavan served as our President from our inception until May 2001. Prior to
co-founding Magma, from July 1994 until February 1997, Mr. Madhavan founded and served as the President and Chief Executive Officer of Ambit Design Systems, Inc., an electronic design automation software company, later acquired by Cadence Design Systems, Inc., an electronic design automation software company.
Roy E. Jewell has served as our President since May 2001 and as one of our directors since July 2001. Mr. Jewell has served as our Chief Operating Officer since March 2001. From March 1999 to September 2000, Mr. Jewell served as the Chief Executive Officer at a company he co-founded, Clarisay, Inc., a supplier of surface acoustic wave filters. From January 1998 to March 1999, Mr. Jewell was a member of the CEO Staff at Avant! Corporation, a provider of software products for integrated circuit designs. From July 1992 to January 1998, Mr. Jewell was the President and Chief Executive Officer of Technology Modeling Associates, Inc. or TMA, subsequently acquired by Avant! Corporation. Prior to that time, Mr. Jewell served in various marketing positions at TMA.
Peter S. Teshima has served as our Corporate Vice President, Finance and Chief Financial Officer since April 2006. He served as our Vice President, Finance from August 2004 to April 2006. As our Vice President, Finance, he managed Magmas worldwide finance organization. From January 2003 to August 2004 he served as Chief Operating Officer and Chief Financial Officer for Hier Design, Inc., a provider of electronic design automation design planning software targeted at the field programmable gate array market space. From February 2000 to December 2002, Mr. Teshima was Chief Financial Officer and Vice President of Finance and Administration at InTime Software, Inc., a provider of electronic design automation software. From November 1998 to January 2000, Mr. Teshima served as the Chief Financial Officer and Vice President of Finance and Administration of Cyclone Commerce a provider of e-commerce and business to business software applications and products. From 1997 to 1998, Mr. Teshima served as Chief Financial Officer and Vice President of Finance and Administration of Avant! Corporation. Mr. Teshimas prior experience includes serving as Chief Financial Officer at interHDL Inc., and High Level Design Systems.
Saeid Ghafouri has served as our Corporate Vice President, Worldwide Field Operations since September 2002. From September 1999 to September 2002 Mr. Ghafouri was President and Chief Executive Officer of Empact Software, Inc., an enterprise software company. He served as President and Chief Executive Officer of an electronic design automation company, interHDL, which was acquired by Avant! Corporation, from April 1998 to September 1999. Prior to that Mr. Ghafouri served in various management positions between June 1996 and April 1998 at Synopsys, Inc., most recently as Vice PresidentBusiness Development for library products. He spent eight years with Cadence Design Systems Inc., between March 1986 and May 1994, where he served in various positions in Sales, Marketing and Applications Engineering.
David H. Stanley has served as our Corporate Vice President, Corporate Affairs since November, 2005 and as our Corporate Secretary since January 2006. From April 2005 to November 2005, Mr. Stanley served as a legal consultant to Magma. From July 2004 to April 2005 Mr. Stanley was an independent legal adviser. Prior to that, Mr. Stanley was Magmas Director for Corporate Development and Strategy from August 2003 to June 2004, in which position Mr. Stanley worked on mergers and acquisitions. From September 1999 until April 2003, Mr. Stanley was general counsel of COLO.COM, a collocation space provider. From October 1997 to September 1999, Mr. Stanley was the general counsel and a member of the CEO Staff of Avant! Corporation. Mr. Stanley received an A.B. degree in economics from Dartmouth College in Hanover, New Hampshire, and a J.D. degree from the University of San Francisco.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the Nasdaq National Market under the symbol LAVA. Public trading commenced on November 20, 2001. Prior to that, there was no public market for our common stock. The following table sets forth, for the periods indicated, the high and low per share sale prices of our common stock, as reported by the Nasdaq National Market on its consolidated transaction reporting system.
As of May 31, 2006, there were 275 holders of record (not including beneficial holders of stock held in street names) of our common stock.
We have not declared or paid cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Our Board of Directors will determine future dividends, if any.
Securities Authorized for Issuance under Equity Compensation Plans
Information relating to securities authorized for issuance under equity compensation plans will be presented under the caption Securities Authorized for Issuance under Equity Compensation Plans in our definitive proxy statement. That information is incorporated into this report by reference.
Recent Sales of Unregistered Securities
During fiscal 2006, on May 24, 2005 and October 2, 2005, we issued 1,157,092 and 107,556 shares, respectively, of our common stock as part of the contingent consideration in connection with our acquisition of Mojave, Inc. pursuant to a definitive agreement signed on February 23, 2004. The contingent share consideration was based on Mojaves achievement of certain technology milestones and product orders. We may issue additional contingent share consideration of up to $46.6 million based on additional product orders over the period ending March 31, 2009. These securities were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 provided by Section 3(a)(10) thereof.
We previously reported that a warrant was issued to IBM in connection with and in partial consideration for a technology license agreement in our Form 8-K filing dated June 30, 2005. This sale of the warrant was made in reliance upon the exemption from the registration requirements of the Securities Act of 1933 provided by Section 4(2) thereof.
Issuer Purchases of Equity Securities
We did not repurchase any shares of our common stock during the fourth quarter of fiscal 2006.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data are qualified by reference to, and should be read in conjunction with, Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related Notes included in Item 8 of this Report. The selected consolidated balance sheet data as of April 2, 2006 and March 31, 2005 and selected consolidated statements of operations data for the years ended April 2, 2006, March 31, 2005 and 2004, are derived from our audited consolidated financial statements included elsewhere in this Report. The selected consolidated balance sheet data as of March 31, 2004, 2003 and 2002 and the selected consolidated statements of operations data for the years ended March 31, 2003 and 2002 were derived from audited consolidated financial statements not included in this Report. Our historical results are not necessarily indicative of our future results.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This Managements Discussion and Analysis of Financial Condition and Results of Operation section should be read in conjunction with Selected Consolidated Financial Data and our condensed consolidated financial statements and results appearing elsewhere in this report. Throughout this section, we make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can often identify these and other forward looking statements by terms such as becoming, may, will, should, predicts, potential, continue, anticipates, believes, estimates, seeks, expects, plans, intends, or comparable terminology. These forward-looking statements include, but are not limited to, our expectations about revenue and various operating expenses. Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: competition in the EDA market; Magmas ability to integrate acquired businesses and technologies; potentially higher-than-anticipated costs of litigation; uncertain outcome of Synopsys litigation; potentially higher-than-anticipated costs of compliance with regulatory requirements, including those relating to internal control over financial reporting; any delay of customer orders or failure of customers to renew licenses; adoption of products by customers; weaker-than-anticipated sales of Magmas products and services; weakness in the semiconductor or electronic systems industries; the ability to manage expanding operations; the ability to attract and retain the key management and technical personnel needed to operate Magma successfully; the ability to continue to deliver competitive products to customers; and changes in accounting rules. Magma undertakes no additional obligation to update these forward looking statements.
Magma Design Automation provides EDA software products and related services. Our software enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation. Our focus is on software used to design the most technologically advanced integrated circuits, specifically those with minimum feature sizes of 0.13 micron and smaller. See Item 1, Business for a more complete description of our business.
As an EDA software provider, we generate substantially all our revenue from the semiconductor and electronics industries. Our customers typically fund purchases of our software and services out of their research and development budgets. As a result, our revenue is heavily influenced by our customers long-term business outlook and willingness to invest in new chip designs.
The semiconductor industry is highly volatile and cost-sensitive. Our customers focus on controlling costs and reducing risk, lowering research and development (R&D) expenditures, cutting back on design starts, purchasing
from fewer suppliers, and requiring more favorable pricing and payment terms from suppliers. In addition, intense competition among suppliers of EDA products has resulted in pricing pressure on EDA products.
To support our customers, we have focused on providing the most technologically advanced products to address each step in the IC design process, as well as integrating these products into broad platforms, and expanding our product offerings. Our goal is to be the EDA technology supplier of choice for our customers as they pursue longer-term, broader and more flexible relationships with fewer suppliers.
Our accomplishments during fiscal 2006 include:
We have acquired companies and purchased technologies that enable us to expand into new markets. We believe that these acquisitions are a significant factor in Magma being able to compete successfully in the EDA industry and we expect to make similar acquisitions in the future. These acquisitions increased our headcount and increased our research and development and sales and marketing expenses. Acquisitions may decrease our liquidity in the short term if earnout milestones are achieved and we must pay contingent cash consideration under the terms of some of these acquisitions.
On November 29, 2005, we acquired ACAD Corporation (ACAD), a privately-held company that develops circuit simulation software, to broaden our product portfolio into simulation, addressing a new market, and to enhance certain other existing Magma products, all of which help IC manufacturers produce higher quality chips more efficiently. The acquisition of ACAD further supports Magmas focus to deliver effective EDA software to IC manufactures, enabling IC designers to meet critical time-to-market objectives, improve chip performance, and handle multimillion-gate designs. We acquired ACAD for an initial consideration of approximately $453,000 in cash and assumption of its net liabilities of approximately $3.9 million. We also agreed to pay up to $5.65 million of cash in contingent consideration to the ACAD shareholders upon achieving or exceeding certain financial and technical milestones. As of April 2, 2006 none of the contingent consideration has been earned.
On March 9, 2006, we acquired certain patents and intellectual property of Reshape, Inc. (ReShape), a privately-held developer of EDA and design flow technology. Pursuant to the asset purchase agreement, we paid ReShape total consideration of $750,000 in cash upon close of the transaction.
On June 30, 2005, we acquired a technology license from International Business Machines Corporation (IBM) to copyrighted material pertinent to technology relating to electronic design automation, as well as other intellectual property owned by IBM. Also in connection with the technology license agreement, IBM and Magma entered into an amendment extending to 2010 the term of Magmas patent license agreement with IBM dated March 24, 2004. These two licenses cover IBMs patents and significant technology with respect to the development of EDA tools and products that perform physical implementation. The total fee for the licenses was $7.0 million paid on June 30, 2005. In connection with the license agreements, we also entered into a warrant agreement pursuant to which IBM is entitled to purchase up to 500,000 shares of Magma common stock at an exercise price of $4.73 per share. The warrant is exercisable immediately and expires on the earlier of June 30, 2010 or immediately prior to a change of control of Magma. The warrant may be exercised by payment of the exercise price in cash or pursuant to a cashless net exercise provision. The fair value was estimated to be $3.1 million in total for the common stock warrant.
During fiscal 2006, a total of $14.2 million of contingent cash consideration was earned on the achievement of certain technology milestones as outlined in various prior asset purchase and business combination agreements with Mojave, Aplus, Lemmatis and PDAT, of which $3.7 million, net of deferred compensation and forfeitures, remains payable as of April 2, 2006.
Critical Accounting Policies and Estimates
In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the most significant potential impact on our financial statements, so we consider these to be our critical accounting policies. We consider the following accounting policies related to revenue recognition, allowance for doubtful accounts, investments, asset purchases and business combinations, income taxes and valuation of long-lived assets to be our most critical policies due to the estimation processes involved in each.
We recognize revenue in accordance with Statement of Position (SOP) 97-2, as modified by SOP 98-9, which generally requires revenue earned on software arrangements involving multiple elements (such as software products, upgrades, enhancements, maintenance, installation and training) to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to us. If evidence of fair value does not exist for each element of a license arrangement and maintenance is the only undelivered element, then all revenue for the license arrangement is recognized over the term of the agreement. If evidence of fair value does exist for the elements that have not been delivered, but does not exist for one or more delivered elements, then revenue is recognized using the residual method, under which recognition of revenue for the undelivered elements is deferred and the residual license fee is recognized as revenue immediately.
Our revenue recognition policy is detailed in Note 1 of the Notes to Consolidated Financial Statements on this Form 10-K. Management has made significant judgments related to revenue recognition; specifically, in connection with each transaction involving our products (referred to as an arrangement in the accounting literature) we must evaluate whether our fee is fixed or determinable and we must assess whether collectibility is probable. These judgments are discussed below.
The fee is fixed or determinable. With respect to each arrangement, we must make a judgment as to whether the arrangement fee is fixed or determinable. If the fee is fixed or determinable, then revenue is recognized upon delivery of software (assuming other revenue recognition criteria are met). If the fee is not fixed or determinable, then the revenue recognized in each period (subject to application of other revenue recognition criteria) will be 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 were being recognized ratably.
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:
In order for an arrangement to be considered fixed or determinable, 100% of the arrangement fee must be due within one year or less from the order date. We have a history of collecting fees on such arrangements according to contractual terms. Arrangements with payment terms extending beyond 12 months are considered not to be fixed or determinable.
Collectibility is probable. In order to recognize revenue, we must make a judgment about 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. 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 receipts basis (as each payment is collected).
We derive license revenue primarily from licenses of our design and implementation software and, to a much lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses.
We recognize license revenue after the execution of a license agreement and the delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed or determinable, collection is probable and there are no remaining obligations other than maintenance. For licenses where we have vendor-specific objective evidence of fair value (VSOE) for maintenance, we recognize license revenue using the residual method. For these licenses, license revenue is recognized in the period in which the license agreement is executed assuming all other revenue recognition criteria are met. For licenses where we have no VSOE for maintenance, we recognize license revenue ratably over the maintenance period, or if extended payment terms exist, based on the amounts due and payable.
For transactions in which we bundle maintenance for the entire license term into a time-based license agreement, no VSOE of fair value exists for each element of the arrangement. For these agreements, where the only undelivered element is maintenance, we recognize revenue ratably over the contract term. If an arrangement involves extended payment termsthat is, where payment for less than 100% of the license, services and initial post contract support is due within one year of the contract datewe recognize revenue to the extent of the lesser of the portion of the amount due and payable or the ratable portion of the entire fee.
For our perpetual licenses and some time-based license arrangements, we unbundle maintenance by including maintenance for up to the first year of the license term, with maintenance thereafter renewable by the customer at the substantive rates stated in their agreements with us. In these unbundled licenses, the aggregate
renewal period is greater than or equal to the initial maintenance period. The stated rate for maintenance renewal in these contracts is VSOE of the fair value of maintenance in both our unbundled time-based and perpetual licenses. Where the only undelivered element is maintenance, we recognize license revenue using the residual method. If an arrangement involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.
If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a particular period. Amounts invoiced relating to arrangements where revenue cannot be recognized are reflected on our balance sheet as deferred revenue and recognized over time as the applicable revenue recognition criteria are satisfied.
We derive services revenue primarily from consulting and training for our software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized on a straight-line basis over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are performed or completed. Our consulting and training services are generally not essential to the functionality of the software. Our products are fully functional upon delivery of the product. Additional factors considered in determining whether the revenue should be accounted for separately include, but are not limited to: degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on our ability to recognize the software license fee.
Unbilled accounts receivable
Unbilled accounts receivable represent revenue that has been recognized in advance of being invoiced to the customer. In all cases, the revenue and unbilled receivables are for contracts which are non-cancelable, there are no contingencies and where the customer has taken delivery of both the software and the encryption key required to operate the software. We typically generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception.
Allowances for doubtful accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customers expected ability to pay and our collection history with each customer. We review significant invoices that are past due to determine if an allowance is appropriate using the factors described above. We also monitor our accounts receivable for concentration in any one customer, industry or geographic region.
The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual losses are significantly greater than the allowance we have established, that would increase our general and administrative expenses and reported net loss. Conversely, if actual credit losses are significantly less than our allowance, this would decrease our general and administrative expenses and our reported net income would increase.
Accounting for asset purchases and business combinations
We are required to allocate the purchase price of acquired assets and business combinations to the tangible and intangible assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible assets.
Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts, acquired workforce and acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; the acquired companys brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined companys product portfolio; and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.
Other estimates associated with the accounting for these acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed resulting in changes in the purchase price allocation.
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of the reporting units. We have determined that we have one reporting unit (see Note 6 of the Notes to the Consolidated Financial Statements under Item 8 of this report). Significant judgments required to estimate the fair value of a reporting unit include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for the reporting unit. Any impairment losses recorded in the future could have a material adverse impact on our financial condition and results of operations.
Valuation of intangibles and long-lived assets
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that we record an impairment charge on finite-lived intangibles or long-lived assets to be held and used when we determine that the carrying value of intangible assets and long-lived assets may not be recoverable. Based on the existence of one or more indicators of impairment, we measure any impairment of intangibles or long-lived assets based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. Our estimates of cash flows require significant judgment based on our historical results and anticipated results and are subject to many factors.
We account for income taxes in accordance with SFAS 109, Accounting for Income Taxes. Significant judgment is required in determining our provision for income taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. The amount of income taxes we pay could be subject to audits by federal, state, and foreign tax authorities, which may result in proposed adjustments. Although we believe that our estimates are reasonable, we cannot guarantee that the final outcome of these tax matters will be no different than what has been reflected in our historical income tax provisions.
We also assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that it is more likely than not that we will not utilize the deferred tax assets, we establish a valuation allowance. We consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years, future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Future increases or decreases in our valuation allowance could have a significant impact on our future earnings.
Strategic investments in privately-held companies
Our strategic equity investments consist of preferred stock and convertible notes that are convertible into preferred or common stock of several privately-held companies. As of April 2, 2006, $0.6 million of the notes has been converted into an investee companys preferred stock. The carrying value of our portfolio of strategic equity investments in non-marketable equity securities (privately-held companies) and convertible notes totaled $2.1 million at April 2, 2006. Our ability to recover our investments in private, non-marketable equity securities and convertible notes, and to earn a return on these investments is primarily dependent on how successfully these companies are able to execute on their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations. In the current equity market environment, their ability to obtain additional funding as well as to take advantage of liquidity events, such as initial public offerings, mergers and private sales, may be significantly constrained.
Under our accounting policy, the carrying value of a non-marketable investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its estimated fair value. For equity investments where our ownership interest is between 20% to 50%, we record our share of net equity income (loss) of the investee based on our proportionate ownership. We review all of our investments periodically for impairment; however, for non-marketable equity securities, the fair value analysis requires significant judgment. This analysis includes assessment of each investees financial condition, the business outlook for its products and technology, its projected results and cash flows, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by us or others. If an investee obtains additional funding at a valuation lower than our carrying amount, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, such as when we hold contractual rights that give us a preference over the rights of other investors. As the equity markets have declined significantly over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If equity market conditions do not improve, as companies within our portfolio attempt to raise additional funds, the funds may not be available to them, or they may receive lower valuations, with more onerous investment terms than in previous financings, and the investments will likely become impaired. However, we are not able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of individual impairments. We recorded impairment charges and share of equity loss related to these non-marketable equity investments of $1.0 million during fiscal 2006.
Results of Operations
Revenue consists of licenses revenue and services revenue. License revenue consists of fees for time-based or perpetual licenses of our products. Services revenue consists of fees for services, such as post-contract customer support (PCS), customer training and consulting. We recognize revenue based on the specific terms and conditions of the license contracts with our customer for our products and services as described in detail above in our Critical Accounting Policies and Estimates. For management reporting and analysis purposes we classify our revenue into the following four categories:
We classify our license arrangements as either bundled or unbundled. Bundled license contracts include maintenance with the license fee and do not include optional maintenance periods. Unbundled license contracts have separate maintenance fees and include optional maintenance periods.
We use this classification of license revenue to provide greater insight into the reporting and monitoring of trends in the components of our revenue and to assist us in managing our business. It is important to note that the characterization of an individual contract may change over time. For example, a contract originally characterized as Ratable may be redefined as Cash Receipts if that customer has difficulty in making payments in a timely fashion. In cases where a contract has been re-characterized for management reporting purposes, prior periods are not restated to reflect that change. The following table shows the breakdown of license revenue by category as defined for management reporting and analysis purposes:
Bundled and Unbundled Licenses: Ratable. For bundled time-based licenses, we recognize license revenue ratably over the contract term, or as customer payments become due and payable, if less. The revenue for these bundled arrangements for both license and maintenance is classified as license revenue in our statement of operations. For unbundled time-based with a term of less than 15 months, we recognize license revenue ratably over the license term, or as customer payments become due and payable, if earlier. For management reporting and analysis purposes, we refer to both these types of licenses generally as Ratable and we generally refer to all time-based licenses recognized on a ratable basis as Long Term, independent of the actual length of term of the license.
We classify unbundled perpetual or time-based licenses with a term of fifteen months or greater based on the payment term structure, as Due and Payable, Cash Receipts or Turns:
Unbundled Licenses: Due and Payable/Time-Based licenses with long term payments. For unbundled time-based licenses where the payment terms extend greater than one year from the arrangement effective date, we recognize license revenue on a due and payable basis and we recognize maintenance and services revenue ratably over the maintenance term. For management reporting and analysis purposes, we refer to this type of license generally as Due and Payable/Long Term Time-Based Licenses.
Unbundled Licenses: Cash Receipts. We recognize revenue from customers who have not met our predetermined credit criteria on a cash receipts basis to the extent that revenue has otherwise been earned. Such customers generally order short-term time based licenses or separate annual maintenance. We recognize license revenue as we receive cash payments from these customers. Maintenance is recognized ratably over the maintenance term after the customer has remitted payment. For management reporting and analysis purposes, we refer to this type of license revenue as Cash Receipts.
Unbundled Licenses: Turns/Perpetual License or Time-Based licenses with short-term payments. For unbundled time-based and perpetual licenses, we recognize license revenue upon shipment as long as the payment terms require the customer to pay 100% of the license fee and the initial period of PCS within one year from the agreement date and payments are generally linear. We recognize maintenance revenue ratably over the maintenance term. In all of these cases, the contracts are non-cancelable, and the customer has taken delivery of both the software and the encryption key required to operate the software. For management reporting and analysis purposes, we refer to this type of license generally as Turns, where the license is either perpetual or time-based.
Our license revenue in any given quarter depends upon the mix and volume of perpetual or short term licenses ordered during the quarter and the amount of long-term ratable or due and payable, and cash receipts license revenue recognized during the quarter. In general, we refer to license revenue recognized from perpetual or time based licenses during the quarter as Up-Front or Turns revenue, for management reporting and analysis purposes. All other types of revenue are generally referred to as revenue from backlog. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve a certain level of orders and a certain mix of short term licenses. The precise mix of orders fluctuates substantially from period to period and affects the revenue we recognize in the period. If we achieve our target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we have more-than-expected long term licenses) or may exceed them (if we have more-than-expected short term or perpetual licenses). If we achieve the target license mix but the overall level of orders is below the target level, then we may not meet our revenue targets as described in the risk factors under Part I, Item 1A, Risk factors.
Revenue, cost of revenue and gross profit
The table below sets forth the fluctuations in revenue, cost of revenue and gross profit from fiscal 2005 to fiscal 2006 and from fiscal 2004 to fiscal 2005 (in thousands, except percentage data):
We market our products and related services to customers in four geographic regions: North America, Europe (Europe, the Middle East and Africa), Japan, and Asia-Pacific. Internationally, we market our products and services primarily through our subsidiaries and various distributors. Revenue is attributed to geographic areas based on the country in which the customer is domiciled. The table below sets forth the fluctuations in geographic distribution of revenue from fiscal 2005 to fiscal 2006 and from fiscal 2004 to fiscal 2005 below (in thousands, except percentage data):
License revenue increased in fiscal 2005 compared to fiscal 2004 primarily due to large orders executed during the fiscal 2005 periods in North America, Europe and Japan. These orders came from existing customers who extended license periods and added license capacity due to the continued proliferation of existing and new Magma products, principally Blast Fusion APX into their design groups. One customer accounted for greater than 10% of the revenue generated in fiscal 2005 and two customers each accounted for greater than 10% of the revenue generated in fiscal 2004. License revenue as a percentage of revenue slightly decreased in fiscal 2005 as compared to fiscal 2004.
Services revenue increased in fiscal 2005 compared to fiscal 2004 primarily due to our large customers accelerating their deployment of our licenses and placing additional services orders.
Domestic revenue increased in fiscal 2005 compared to fiscal 2004 primarily due to our existing customers in North America purchasing additional licenses and the new technology products. Domestic revenue as a percentage of total revenue slightly increased in fiscal 2005 compared to fiscal 2004.
International revenue increased in fiscal 2005 compared to fiscal 2004 primarily due to our existing customers in Japan and Asia-Pacific purchasing additional capacity of existing licenses and licenses to new technology products. International revenue as a percentage of total revenue slightly decreased in fiscal 2005 compared to fiscal 2004.
Cost of revenue
Cost of revenue includes amortization of acquired developed technology and other intangible assets, software maintenance costs, royalties and allocated outside sale representative expenses. Cost of revenue also includes personnel and related costs to provide product support, consulting services and training, as well as asset depreciation, allocated outside sale representative expenses and amortization of deferred stock-based compensation.
The table below (in thousands, except percentage data) sets forth the fluctuations in operating expenses from fiscal 2005 to fiscal 2006 and from fiscal 2004 to fiscal 2005:
Research and development expense increased by $15.6 million in fiscal 2005 compared to fiscal 2004 primarily due to an increase in payroll related expenses of $9.4 million, resulting from an approximate 21% increase in our research and development headcount through direct hiring and business acquisitions. The increase was also caused by higher amortization of acquired technology of $2.7 million and higher allocated common expenses (e.g., facility related expenses) of $3.6 million resulting from the headcount increase. The remainder of the fluctuation in research and development expenses was accounted for by other individually insignificant items.
We expect our research and development expenses, net of stock-based compensation, in fiscal 2007 to increase significantly compared to the amount in fiscal 2006, as our research and development headcount will increase driving up both fixed and variable compensation levels.
Sales and marketing expense increased by $7.7 million in fiscal 2005 compared to fiscal 2004 primarily due to an increase in payroll related expenses of $5.9 million as we increased our sales and marketing headcount by 12% (primarily application engineers), through direct hire as well as business acquisitions during fiscal 2005. The increase was also caused by an increase in commission expense of $1.9 million as a result of sales and bookings growth experienced in fiscal 2005. The remainder of the fluctuation in sales and marketing expense was accounted for by other individually insignificant items.
We expect our sales and marketing expense, net of stock-based compensation, in fiscal 2007 to increase moderately compared to the amount in fiscal 2006, as our field application engineering support headcount will increase driving up both fixed and variable compensation levels.
General and administrative expense increased by $6.7 million in fiscal 2005 compared to fiscal 2004 primarily due to increases in professional service fees of $4.9 million, facility related expenses of $2.3 million, asset depreciation of $3.1 million and an increase in payroll related expenses of $1.7 million as we increased our general and administrative headcount by 15% in fiscal 2005, partially offset by reduced allocated cost of $6.5 million due to higher headcount in other functional areas. The increase in professional service fees in fiscal 2005 was primarily due to the increase in our activities related to the Sarbanes-Oxley Act of 2002, as well as legal expenses related to patent litigation with Synopsys, Inc. The remainder of the fluctuation in general and administrative expense was accounted for by other individually insignificant items.
We expect our general and administrative expense, net of stock-based compensation, to increase moderately in fiscal 2007 compared to 2006 as we continue to be impacted by legal expenses related to patent litigation with Synopsys and professional services related to compliance with the requirements of the Sarbanes-Oxley Act of 2002.
Amortization of intangible assets increased by $16.3 million in fiscal 2005 compared to fiscal 2004 primarily due to result of the full fiscal year amortization of intangible assets recorded in connection with business combinations and asset purchases completed during fiscal 2004, as well as amortization of intangible assets acquired in fiscal 2005.
The intangible assets amortized include licensed technology, patents, trademarks, customer contracts, customer relationships, no shop rights, non-competition agreements and assembled workforces that were identified in the purchase price allocation for each business combination and asset purchase transaction.
Amortization of deferred stock-based compensation decreased by $5.2 million in fiscal 2005 compared to fiscal 2004 primarily due to a decrease in amortization of deferred stock-based compensation of $3.6 million related to the acquisition of VeraTest, a decrease in deferred stock-based compensation charges
of $2.7 million related to the stock options granted to one of the our senior executives in fiscal 2004, and a decrease in amortization of deferred stock-based compensation of $0.4 million (recorded in connection with our IPO in November 2001). These decreases in amortization of deferred stock-based compensation in fiscal 2005 compared to fiscal 2004 were partially offset by the recording of stock- based compensation expenses of $0.7 million related to our Mojave acquisition and $0.8 million related to restricted stock issued under our 2005 Key Contributor Long-Term Incentive Plan.
In June 2005, we offered a voluntary stock option exchange program to our employees which resulted in variable accounting treatment for, at the time of the exchange, options to purchase an aggregate of approximately 5.5 million shares of our common stock. We are accounting for all replacement stock options, as well as all options that were subject to the exchange program but were retained by employees, using variable accounting until our adoption of SFAS 123R in the first fiscal quarter of 2007. Under variable accounting, cumulative stock compensation expense at any balance sheet date must equal accumulated amortization of the current intrinsic value of the outstanding variable stock awards recorded prospectively from the date variable accounting commences over their remaining vesting periods. With the adoption of SFAS 123R, in accordance with its rules, the amount of stock compensation expense will be fixed based on initial estimated fair values of the replacement stock options and amortized over the remaining vesting periods of these options. Stock compensation expense recognized prior to adoption of SFAS 123R using variable accounting will not be reversed upon adoption.
As prescribed by SFAS 123R, we will be required to recognize the compensation costs relating to share-based payment transactions in our financial statements, using the fair value method, starting from our first fiscal quarter of 2007. We expect the adoption of SFAS 123R will increase our share-based compensation expense significantly, however we cannot quantify the amount of such increase at this time. In addition, with the adoption of SFAS 123R in the first fiscal quarter of 2007, the deferred compensation will no longer be presented as a separate line on our statement of operations, instead, it will be reflected throughout our other operating expenses such as research and development, sales and marketing, and general and administrative expenses.
The table below (in thousands, except percentage data) sets forth the fluctuations in other items from fiscal 2005 to fiscal 2006 and from fiscal 2004 to fiscal 2005:
Interest income decreased in fiscal 2005 compared to fiscal 2004 primarily due to our maintaining a lower average cash and investments balance during fiscal 2005. The average cash balance was higher
during fiscal 2004 because we had received $124.8 million of net proceeds in connection with our convertible subordinated debt offering, common stock warrant and bond hedge transactions, all of which were completed in May 2003.
Interest expense in fiscal 2005 and 2004 primarily consisted of amortization of debt discount and issuance costs, which were recorded in connection with our convertible subordinated debt offering completed in May 2003. Annual interest expense is approximately $1.0 million for the amortization of debt discount and issuance costs before the repurchase in May 2005.
Other expense, net increased in fiscal 2005 compared to fiscal 2004 primarily due to a negative change in foreign exchange gain/loss of $1.5 million in fiscal 2005, partially offset by a $0.3 million decrease in charges associated with other than temporary impairment in our strategic investments. The increase of foreign exchange loss in fiscal 2005 was caused by an unfavorable exchange rate fluctuation between the U.S. Dollar and the Japanese Yen. The remainder of the fluctuation in other expense, net was accounted for by other individually insignificant items.
We are in a net deferred tax asset position, for which a full valuation allowance has been recorded. We will continue to provide a valuation allowance on our net deferred tax assets until it becomes more likely than not that the deferred tax assets will be realizable. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.
In the event of a future change in ownership, as defined under federal and state tax laws, our net operating loss and tax credit carryforwards may be subject to an annual limitation. The annual limitations may result in an increase to our current income tax provision and/or the expiration of the net operating loss and tax credit carryforwards before realization.
Liquidity and Capital Resources
During the fourth quarter of fiscal 2005, we reclassified auction rate securities of $55.1 million as of March 31, 2004 from cash and cash equivalents to short-term investments on our consolidated balance sheets. We have reclassified the purchases and sales of these auction rate securities in our consolidated statements of cash flows, which decreased our cash used in investing activities by $3.4 million for the year ended March 31, 2004.
Our cash, cash equivalents, short-term investments and long-term marketable securities, excluding restricted cash, were (a) approximately $97.2 million at April 2, 2006, a decrease of $38.4 million or 28% from March 31, 2005; and (b) approximately $135.5 million at March 31, 2005, a decrease of $15.3 million or 10% from March 31, 2004. These changes primarily reflected cash generated from operations and proceeds from common stock issuances, which in both fiscal 2006 and 2005 were more than offset by cash used for repurchase of common stock, purchases of intangible assets, equity investments and capital investments, and in fiscal 2006, were also offset by cash used for repurchase of a portion of the convertible subordinated notes. Our investment portfolio consists of high-grade fixed-income securities diversified among corporate, U.S. agency and municipal issuers with maturities of two years or less. A portion of the portfolio is allocated to auction rate securities which provide liquidity at par every 28 days with underlying longer-term maturities.
Repurchases of common stock
On April 13, 2005, we announced that our Board of Directors authorized Magma to repurchase up to 2,000,000 shares of our common stock. The stock repurchase program was completed in May 2005 and we used approximately $16.0 million to repurchase 2,000,000 shares of common stock. 1,000,000 of the repurchased shares are reserved for the Magmas 2004 Employment Inducement Award Plan and the remaining 1,000,000 shares are to be used for general corporate purposes.
On July 28, 2004, we announced that our Board of Directors authorized Magma to repurchase up to 1,000,000 shares of common stock. The repurchase was completed in the second quarter of fiscal 2005 and we used approximately $16.6 million to repurchase 1,000,000 shares of common stock. The repurchased shares are to be used for Magmas 2004 Employment Inducement Award Plan.
Repurchases of convertible subordinated notes
On May 22, 2003, we issued $150.0 million principal amount of Zero Coupon Convertible Subordinated Notes due May 15, 2008 (the Notes) resulting in net proceeds to us of approximately $145.1 million. The Notes do not bear coupon interest and are convertible into shares of our common stock at an initial conversion price of $22.86 per share, for an aggregate of approximately 6.56 million shares. The Notes are subordinated to our existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of our subsidiaries. We may not redeem the Notes prior to their maturity date. In order to minimize the dilutive effect from the issuance of the Notes, we undertook the following additional transactions concurrent with the issuance of the Notes:
In May 2005, we repurchased, in privately negotiated transactions, $44.5 million face amount (or approximately 29.7 percent of the total) of these notes at an average discount to face value of approximately 22 percent. We spent an aggregate of approximately $34.8 million on the repurchase. The repurchase left approximately $105.5 million aggregate principal amount of convertible subordinated notes outstanding. At the same time we terminated a portion (approximately 29.7 percent) of the hedging arrangements.
In May 2006, we repurchased, in privately negotiated transactions, an additional $40.3 million face amount (or approximately 38.2 percent of the remaining principal) of these notes at an average discount to face value of approximately 13 percent. We spent an aggregate of approximately $35.0 million on the repurchase. The repurchase left approximately $65.2 million aggregate principal amount of convertible subordinated notes outstanding. At the same time we terminated a portion of the hedging arrangements.
Net cash provided by operating activities
Net cash provided by operating activities increased by $3.1 million to $40.2 million in fiscal 2006 compared to fiscal 2005. The increase was primarily due to a $22.2 million increase in cash from customers, a $8.2 million decrease in payments associated with accounts payable and accrued liabilities and a $1.6 million increase in cash from interest income. These increases in cash flow were partially offset by a $28.1 million increase in costs and expenses, and a $0.8 million increase in payments associated with prepaid and other assets balances. The increase in cash from customers was primarily due to growth in revenue and strong cash collection in fiscal 2006 compared to fiscal 2005. The payment of accrued liabilities in fiscal 2005 was primarily related to a payout of accrued bonuses during the period.
Net cash provided by operating activities was increased by $12.4 million to $37.1 million in fiscal 2005 compared to fiscal 2004. The increase was primarily due to a $39.5 million increase in cash from customers and a $6.4 million change in prepaid and other assets balances. Prepaid and other assets decreased by $1.5 million in fiscal 2005 and increased by $4.9 million in fiscal 2004. These increases were partially offset by a $30.5 million increase in costs and operating expenses and a $2.6 million increase in payments associated with accounts payable and accrued liabilities. The increase in cash from customers was primarily due to growth in revenue and strong cash collection during fiscal 2005 compared to fiscal 2004. The decrease in prepaid expenses was primarily caused by decreases in prepaid commission expense and prepaid software maintenance expense. Prepaid commission decreased during fiscal 2005 primarily due to orders recorded in fiscal 2003 of approximately $100.0 million for which we paid advance commissions but where the entire order value has not been recognized as revenue in fiscal 2003. The advance commission balance decreases during years after fiscal 2003 as these orders are recognized as revenue in subsequent periods. The payment of accrued liabilities during fiscal 2005 was primarily related to a payout of accrued bonuses during the period.
Net cash provided by/used in investing activities
Net cash provided by investing activities was $43.1 million in fiscal 2006. We had net proceeds of $76.4 million from sales of marketable securities as we liquidated these investments to repurchase a portion of the
convertible subordinated notes as well as to repurchase 2,000,000 shares of common stock. Partially offsetting the cash inflow, we used a total of $11.6 million in cash to acquire ACAD, to purchase a technology license from IBM and patents from ReShape. We also made earnout payments totaling $14.5 million on milestone payments relating to Mojave and other prior asset purchases. We also made an investment of $0.8 million in a privately held technology company for business and strategic purposes. We may make additional strategic equity investments in the future by using our cash, cash equivalents and/or short-term investments. In addition, we acquired property and equipment totaling $6.5 million in cash and $2.4 million through capital leases. We expect to make capital expenditures of approximately $10.7 million in fiscal 2007. These capital expenditures will be used to support selling, marketing and product development activities. We will use capital lease financing as well as our cash and cash equivalents and/or short-term investments to fund these purchases.
Net cash used in investing activities was $27.7 million in fiscal 2005. In order to broaden our product offerings and to incorporate certain key technologies into our existing products, we used a total of $13.2 million in cash, net of cash acquired, to complete the Mojave, Lemmatis, Fortis and other asset purchase transactions during fiscal 2005. We also made earnout payments totaling $17.8 million on milestone payments relating to prior asset purchases. In addition, we made net investments of $1.3 million in several privately held technology companies for business and strategic purposes. We may make additional strategic equity investments in the future by using our cash and cash equivalents and investments. We had net proceeds of $17.3 million from sales of marketable securities as we liquidated these investments to repurchase 1,000,000 shares of common stock. In fiscal 2005 we acquired property and equipment totaling $12.7 million. The property and equipment expenditures were primarily for purchases of computer equipment and research and development tools to support our growing operations.
Net cash used in investing activities was $140.7 million in fiscal 2004. We used cash to complete 4 business combination and 4 asset purchase transactions during fiscal 2004 in order to broaden our product offerings and to incorporate certain key technologies into our existing products and paid a total of $78.6 million in cash, net of cash acquired. In connection with two of these transactions, we maintain restricted cash of $2.7 million to secure certain indemnification obligations. We also made equity investments of $2.1 million in several privately held technology companies for business and strategic purposes. We had a net purchase of $44.0 million of short and long-term investments as we invested the proceeds received from our convertible subordinated notes offering completed in May 2003. During fiscal 2004, we acquired property and equipment totaling $13.7 million.
Net cash provided by/used in financing activities
Net cash used in financing activities was $45.2 million in fiscal 2006. We used $34.8 million to repurchase a portion of our convertible subordinated notes and received net proceeds of $140,000 from termination of the related portion of the bond hedge and warrant. In addition, we used $16.0 million to repurchase 2,000,000 shares of common stock on the open market, as authorized by the board of directors in April 2005, and made payments of $0.8 million on our capital leases. The primary source of cash was $6.3 million in cash received from the exercise of stock options and shares purchased under the employee stock purchase plan during the period.
Net cash used in financing activities was $6.4 million in fiscal 2005. The sole source of cash was $10.4 million of cash received from the exercise of stock options and shares purchased under the employee stock purchase plan during the period. We used $16.6 million to repurchase 1,000,000 shares of common stock on the open market, as authorized by the board of directors in July 2004.
Net cash provided by financing activities was $127.0 million in fiscal 2004. The primary source of cash was the net proceeds received from issuance of convertible subordinated notes (the Debt Offering) of $145.1 million. In connection with the Debt Offering, we also issued a warrant exercisable for shares of our common stock to a bank and received additional cash proceeds of $35.9 million, while we paid $56.2 million in cash for entering into a bond hedge contract with the same bank. Other sources of cash included $24.1 million of cash received from the exercise of stock options and shares purchased under the employee stock purchase plan and
$0.2 million of repayment received for the notes receivable from stockholders. These cash inflows were offset by our $2.1 million repayment of notes payable to a bank and our repurchase of 1.1 million shares of our common stock for $20.0 million in order to minimize the dilutive effect of the Debt offering.
We believe that our existing cash and cash equivalents and short-term investments will be sufficient to meet our anticipated operating and working capital expenditure requirements in the ordinary course of business for at least the next 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may use cash or need to sell additional equity or debt securities. The sale of additional equity or convertible debt securities may result in more dilution to our existing stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.
Our acquisition agreements related to certain business combination and asset purchase transactions obligate us to pay certain contingent cash and stock considerations based on meeting certain booking or project milestones and continued employment. Total amounts of cash and stock contingent consideration that could be paid or issued under our acquisition agreements, assuming all contingencies are met, were $49.4 million and $42.7 million, respectively, as of April 2, 2006. The number of contingent shares to be issued depends on the market price of our common stock near when the milestones are achieved.
As of April 2, 2006, our principal commitments consisted of operating leases, with an aggregated future obligation amount of $11.8 million through fiscal 2011, for office facilities, capital leases for computer equipment, and repayment of the convertible subordinated notes of $105.5 million due in fiscal 2009. Although we have no material commitments for capital expenditures, we anticipate a substantial increase in our capital expenditures and lease commitments with our anticipated growth in operations, infrastructure, and personnel.
The table below summarizes our significant contractual obligations at April 2, 2006, and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in millions):
Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the course of business for which we have not received the goods or services as of April 2, 2006. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.
In May 2006, we repurchased, in privately negotiated transactions, an additional $40.3 million face amount of the convertible subordinated notes. The repurchase left approximately $65.2 million aggregate principal amount of convertible subordinated notes outstanding.
In addition to the enforceable and legally binding obligations quantified in the table above, we have other obligations for goods and services entered into in the normal course of business. These obligations, however, either are not enforceable or legally binding or are subject to change based on our business decisions.
Off-balance sheet arrangements
As of April 2, 2006, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
We enter into standard license agreements in the ordinary course of business. Pursuant to these agreements, we agree to indemnify our customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to our products. These indemnification obligations have perpetual terms. Our normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification we may be required to make may exceed its normal business practices. We estimate the fair value of its indemnification obligations as insignificant, based on our historical experience concerning product and patent infringement claims. Accordingly, we have no liabilities recorded for indemnification under these agreements as of April 2, 2006.
We have agreements whereby our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a directors and officers insurance policy that reduces our exposure and enables us to recover a portion of future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of April 2, 2006.
In connection with recent business acquisitions, we agreed to assume, or cause our subsidiaries to assume, indemnification obligations to the officers and directors of acquired companies.
We offer our customers a warranty that our products will conform to the documentation provided with the products. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations. Accordingly, we have no liabilities recorded for these warranties as of April 2, 2006. We assess the need for a warranty accrual on a quarterly basis, and there can be no guarantee that a warranty accrual will not become necessary in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities, substantially all of which mature within the next twenty-four months. As of April 2, 2006, a hypothetical 100 basis point increase in interest rates would result in approximately a $25,000 decline in the fair value of our available-for-sale securities.
The fair value of our fixed rate long-term debt is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of our debt, due to differences between market interest
rates and rates in effect at the inception of our debt obligation. Changes in the fair value of our fixed rate debt have no impact on our cash flows or consolidated financial statements.
We completed an offering on May 22, 2003 of $150.0 million principal amount of convertible subordinated notes due May 15, 2008. Concurrent with the issuance of the convertible notes, we entered into convertible bond hedge and warrant transactions with respect to our common stock, the exposure for which is held by Credit Suisse First Boston International. Both the bond hedge and warrant transactions may be settled at our option either in cash or net shares and expire on May 15, 2008. The transactions are expected to reduce the potential dilution from conversion of the notes. Subject to the movement in the share price of our common stock, we could be exposed to credit risk in the settlement of these options in our favor. Based on a review of the possible net settlements and the credit strength of Credit Suisse First Boston International and its affiliates, we believe that we do not have a material exposure to credit risk arising from these option transactions.
In May 2006 and May 2005, we repurchased $40.3 million and $44.5 million, respectively, face value of our convertible notes for $35.0 million and $34.8 million, respectively. In doing so, we liquidated investments that generated a realized loss of approximately $3,000 and $661,000, respectively. We believe that it was in the best interests of the stockholders to reduce the balance sheet debt despite the one-time loss resulting from the liquidation of marketable securities. Our investments that matured in the months following the repurchase were reinvested in short-term instruments in order to take advantage of rising short-term rates.
Foreign Currency Exchange Rate Risk
A majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, we transact some portions of our business in various foreign currencies, primarily related to a portion of revenue in Japan and operating expenses in Europe, Japan and Asia-Pacific. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. As of April 2, 2006, we had no currency hedging contracts outstanding. We do not currently use financial instruments to hedge revenue and operating expenses denominated in foreign currencies. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
MAGMA DESIGN AUTOMATION, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements and Financial Statement Schedule
MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Magma Design Automation (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.
We assessed the effectiveness of the Companys internal control over financial reporting as of April 2, 2006. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework. Based on our assessment using those criteria, we concluded that our internal control over financial reporting was effective as of April 2, 2006.
Managements assessment of the effectiveness of the Companys internal control over financial reporting as of April 2, 2006 has been audited by Grant Thornton LLP, the Companys independent registered public accounting firm, as stated in their report which is included in this report for the year ended April 2, 2006.
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders of
Magma Design Automation, Inc.
We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting as of April 2, 2006, that Magma Design Automation, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of April 2, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment, and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that the Company maintained effective internal controls over financial reporting as of April 2, 2006, is fairly stated in all material respects, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of April 2, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Magma Design Automation, Inc. as of April 2, 2006, and the related consolidated statements of operations, stockholders equity, and cash flows for the year ended April 2, 2006 and our report dated June 7, 2006 expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
San Jose, CA
June 7, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Magma Design Automation, Inc.
We have audited the consolidated balance sheet of Magma Design Automation, Inc. and subsidiaries as of April 2, 2006, and the related consolidated statements of operations, stockholders equity and cash flows for the year ended April 2, 2006. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Magma Design Automation, Inc. as of April 2, 2006, and the consolidated results of their operations and their consolidated cash flows for the year ended April 2, 2006, in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is presented for purposes of additional analysis and is not a required part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
We also have audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Magma Design Automation Inc.s internal control over financial reporting as of April 2, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated June 7, 2006, expressed an unqualified opinion on managements assessment of, and an unqualified opinion on the effective operation of, internal control over financial reporting.
/s/ Grant Thornton LLP
San Jose, California
June 7, 2006
To the Board of Directors and Stockholders of
Magma Design Automation, Inc.:
In our opinion, the consolidated balance sheet as of March 31, 2005 and the related consolidated statements of operations, stockholders equity and cash flows for each of the two years in the period ended March 31, 2005 present fairly, in all material respects, the financial position of Magma Design Automation, Inc. and its subsidiaries at March 31, 2005, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2005, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for each of the two years in the period ended March 31, 2005 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
San Jose, California
June 14, 2005
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands, except share data)
MAGMA DESIGN AUTOMATION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY(Continued)
(in thousands, except share data)