Synopsys 10-Q 2006
WASHINGTON, D.C. 20549
COMMISSION FILE NUMBER: 0-19807
(Exact name of registrant as specified in its charter)
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Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
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Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
143,884,846 shares of Common Stock as of March 4, 2006
QUARTERLY REPORT ON FORM 10-Q
JANUARY 31, 2006
TABLE OF CONTENTS
(in thousands, except par value amounts)
See accompanying notes to unaudited condensed consolidated financial statements.
(in thousands, except per share amounts)
See accompanying notes to unaudited condensed consolidated financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.
1. BASIS OF PRESENTATION
Synopsys, Inc. (Synopsys or the Company) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the Commission. Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with generally accepted accounting principles (GAAP). In managements opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its financial position, results of operations and cash flows. The Companys interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys Annual Report on Form 10-K for the fiscal year ended October 31, 2005 on file with the Commission.
To prepare financial statements in conformity with GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates and material effects on the Companys operating results and financial position may result.
Certain prior year amounts have been reclassified to conform to the current year presentation. The Company has reclassified certain prior year amounts relating to deferred compensation as detailed in the statements of operations and in Note 2.
Synopsys fiscal year and first fiscal quarter ended on the Saturday nearest October 31 and January 31, respectively. Fiscal 2006 and 2005 are both 52-week years. For ease of presentation, the unaudited condensed consolidated financial statements and accompanying notes refer to the applicable calendar month end.
2. STOCK-BASED COMPENSATION
Adoption of SFAS 123(R)
On November 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)) which requires the measurement of stock-based compensation expense for all share-based payment awards made to employees for services. In January 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 107, which provided supplemental implementation guidance for SFAS 123(R). Prior to November 1, 2005, the Company accounted for its share-based compensation plans using the intrinsic value method under the recognition and measurement provisions of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees (APB 25) and related guidance. Under the intrinsic value method, the Company did not recognize any significant amount of stock-based compensation expense in the Companys consolidated statements of operations, as options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
The Company has elected to adopt the modified-prospective transition method permitted by SFAS 123(R) and accordingly prior periods have not been restated to reflect the impact of SFAS 123(R). The modified prospective transition method requires that stock-based compensation expense be recorded for (a) any share-based payments granted through, but not yet vested as of October 31, 2005 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123, and (b) any share-based payments granted subsequent to October 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). The Company has recorded $18.4 million of stock-based compensation expense during the first quarter of 2006 as a result of the adoption of SFAS 123(R). In accordance with SFAS 123(R), the Company will present excess tax benefits from the exercise of stock options as a financing activity in the consolidated statements of cash flows. The Company did not record any excess tax benefits for the three months ended January 31, 2006.
The Company estimates the fair value of stock options using a Black-Scholes option-pricing model to determine the fair value of stock-based awards under SFAS 123(R), and consistent with that used for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation prior to the adoption of SFAS No. 123(R). The Black-Scholes option pricing model was developed for use in estimating the fair value of short lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model incorporates various and highly subjective assumptions including expected volatility, expected term and interest rates. The expected volatility is based on
historical volatility of the Companys common stock over the most recent period commensurate with the estimated expected term of the Companys stock options. The expected term of the Companys stock options are based on historical experience.
The assumptions used to estimate the fair value of stock options granted and stock purchase rights granted under our Employee Stock Purchase Plan for the three months ended January 31, 2006 and 2005 are as follows:
The following table illustrates the effect on net loss after taxes and net loss per share for the three months ended January 31, 2005 if it had applied the fair value recognition provisions of SFAS 123 to share-based compensation using the Black-Scholes model. Prior year stock-based compensation has been adjusted for the related tax effects.
As of January 31, 2006, there was $115.8 million of unrecognized stock-based compensation expense related to approximately 11.9 million unvested stock awards net of 0.7 million of estimated stock award forfeitures. This cost is expected to be recognized over a weighted-average period of approximately 2.2 years. The total intrinsic value of options exercised in the first quarter of fiscal 2006 and fiscal 2005 were $3.0 million and $0.8 million, respectively.
The compensation cost that has been charged against our results of operations and the total income tax benefit, if any, that the Company recognized on our statement of operations for these share-based compensation arrangements was as follows for the first quarters of fiscal 2006 and 2005 (in thousands):
Prior to the adoption of SFAS 123(R), the Company presented deferred compensation as a separate component of stockholders equity. In accordance with the provisions of SFAS 123(R), on November 1, 2005 the Company reclassified the balance in deferred compensation to additional paid-in capital on its balance sheet. Prior to the adoption of SFAS 123(R), the Company presented all tax benefits for deductions resulting from the exercise of stock options as operating cash flows on its statement of cash flows. SFAS 123(R) requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for those options (excess tax benefits) to be classified as financing cash flows. The Company recorded no excess tax benefits for the three months ended January 31, 2006. Prior year amounts have been reclassified to conform to current years presentation.
Employee Stock Benefit Plans
Employee Stock Purchase Plan
Under the Companys Employee Stock Purchase Plan and International Employee Stock Purchase Plan (collectively, the ESPP), employees are granted the right to purchase shares of common stock at a price per share that is 85% of the lesser of the fair market value of the shares at (i) the beginning of a rolling two-year offering period or (ii) the end of each semi-annual purchase period, subject to a plan limit on the number of shares that may be purchased in a purchase period. During the fiscal quarters ended January 31, 2006 and 2005, respectively, the Company issued no additional shares under the ESPP. As of January 31, 2006, 7,828,034 shares of common stock were reserved for future issuance under the ESPP.
Stock Option Plans
1992 Stock Option Plan
Under the Companys 1992 Stock Option Plan (the 1992 Plan), 38,866,356 shares of common stock have been authorized for issuance. Pursuant to the 1992 Plan, the Board of Directors (the Board) may grant either incentive or non-qualified stock options to purchase shares of common stock to employees or consultants, excluding non-employee directors at not less than 100% of the fair market value of those shares on the grant date. Stock options granted under the 1992 Plan generally vest over a period of four years and expire seven to ten years from the date of grant. As of January 31, 2006, 9,372,580 stock options remain outstanding and 5,519,303 shares of common stock are reserved for future grants under this plan.
Under the 1992 Plan, certain executive officers of the Company were granted an aggregate total of 420,000 stock options whose vesting is contingent upon meeting Company-wide operating margin performance goals. These shares were granted at the fair market value on the date of grant and contingently vest over two years and have contractual life of seven years. Stock-based compensation expense is recorded assuming that performance goals will be achieved.
1998 Non-Statutory Stock Option Plan
Under the Companys 1998 Non-Statutory Stock Option Plan (the 1998 Plan), 50,295,546 shares of common stock have been authorized for issuance. Pursuant to the 1998 Plan, the Board may grant nonqualified stock options to employees or consultants, excluding executive officers. Exercisability, option price and other terms are determined by the Board but the option price shall not be less than 100% of the fair market value of those shares on the grant date. Stock options granted under the 1998 Plan generally vest over a period of four years and expire seven to ten years from the date of grant. As of January 31, 2006, 25,478,599 stock options remain outstanding and 2,189,134 shares of common stock were reserved for future grants under this plan.
2005 Assumed Stock Option Plan
Under the Companys 2005 Assumed Stock Option Plan (formerly, the Nassda Corporation 2001 Stock Option Plan), an aggregate of 3,427,529 shares of common stock have been authorized for issuance. Pursuant to the 2005 Plan, the Compensation Committee of the Board or its designee can grant nonqualified stock options to employees or consultants of the Company who either were (i) not employed by the Company or any of its subsidiaries on May 11, 2005 or (ii) providing services to Nassda Corporation (or any subsidiary corporation thereof) prior to May 11, 2005. Exercisability, option price and other terms are determined by the Board but the option price shall not be less than 100% of the fair market value of those shares on the grant date. Stock options granted under the 2005 Plan generally vest over a period of four years and expire seven to ten years from the date of grant. As of January 31, 2006, 1,012,871 stock options remain outstanding and 2,237,613 shares of common stock were reserved for future grant under this plan.
2005 Non-Employee Directors Equity Incentive Plan
On May 23, 2005 the Companys stockholders approved the 2005 Non-Employee Directors Equity Incentive Plan (the Directors Plan) and the reservation of 300,000 shares of common stock for issuance thereunder. The Directors Plan provides for annual equity awards to non-employee directors in the form of either stock options or restricted stock. On May 23, 2005, the Company issued non-employee directors an aggregate of 42,060 shares of restricted stock with an aggregate value of approximately $0.75 million on the date of grant. The stock-based compensation expense related to these shares will be amortized over the vesting period of three years. As of January 31, 2006, 257,940 shares of common stock were reserved for future grant under the Directors Plan.
1994 Non-Employee Directors Stock Option Plan
An aggregate of 1,080,162 stock options remain outstanding under the Companys 1994 Non-Employee Directors Stock Option Plan, which expired as to future grants in October 2004.
The Company has assumed certain option plans in connection with business combinations with respect to stock options outstanding at the time of such business combinations. Generally, the options granted under these plans have terms similar to the Companys own options. The exercise prices of such options have been adjusted to reflect the relative exchange ratios. Other than the 2005 Assumed Stock Option Plan, no shares were reserved for future grant under these plans.
Option Exchange Program
During the third quarter of fiscal 2005, our Board of Directors approved an option exchange program under which outstanding employee stock options (other than options held by executive officers) with exercise prices of $25.00 or greater per share could be exchanged for a lesser number of options granted at current fair market value and with a new vesting period. The Board adopted this program due to the fact that the exercise prices of a large number of outstanding employee stock options were significantly below the Companys stock price and thus did not provide adequate employee incentive. The Companys stockholders approved the program in May 2005. As a result, on June 23, 2005, the Company accepted for cancellation options to purchase 7.3 million shares of common stock and in exchange granted to eligible employees options to purchase 3.8 million shares of the Companys common stock at an exercise price of $17.16 per share, except for options to purchase approximately 22,000 shares which were issued with an exercise price of $18.06 due to regional laws regarding the pricing of stock option grants. Approximately 3.6 million options were retired in connection with the option exchange program. As a result of the exchange, the Company used variable accounting for all options eligible for the exchange under the provisions of APB 25 and related interpretations until the adoption of SFAS 123(R) on November 1, 2005. Total compensation expense recorded with respect to these options for the fiscal year ended October 31, 2005 was $0.6 million.
Additional Information about Stock Options
The following table summarizes stock option activity during the first quarter of fiscal 2006 under all plans:
(1) Excludes 257,940 shares reserved for future issuance under the 2005 Non-Employee Directors Equity Incentive Plan, which may be issued as restricted stock or stock options.
The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Companys closing stock price of $21.83 as of January 27, 2006, which would have been received by the option holders had all option holders exercised their options as of that date.
The following table summarizes significant ranges of outstanding and exercisable options as of January 31, 2006.
The following table summarizes our unvested stock activity for the three months ended January 31, 2006.
3. BUSINESS COMBINATIONS
Acquisition of HPL Technologies, Inc. (HPL)
The Company acquired HPL on December 7, 2005.
Reasons for the Acquisition. The Company believes that the acquisition will help solidify the Companys position as a leading EDA vendor in design for manufacturing (DFM) software and would give the Company a comprehensive design-to-silicon flow that links directly into the semiconductor manufacturing process. Integrating HPLs yield management and test chip technologies into the Companys industry-leading DFM portfolio will also enable customers to increase productivity and improve profitability in the design and manufacture of advanced semiconductor devices and will broaden Synopsys DFM research and development expertise by adding HPLs team of experienced engineers. The results of operations of HPL are included in the accompanying unaudited condensed consolidated statement of operations since the date of the acquisition. The Company does not consider the acquisition of HPL to be material to its results of operations, and therefore is not presenting pro forma statements of operations for the three-month periods ended January 31, 2006 and 2005.
Purchase Price. The Company paid $11.0 million in cash on December 7, 2005 for all outstanding shares of HPL. In addition, the Company had a prior investment in HPL for $1.9 million. The total purchase consideration consisted of:
Acquisition-related costs of $3.6 million consist primarily of legal, tax and accounting fees of $1.3 million, $0.4 million of estimated facilities closure costs and other directly related charges, $1.0 million in estimated contract termination costs, and $0.9 million in severance and other employee termination costs. As of January 31, 2006, the Company had paid $1.5 million of the acquisition related costs, of which $0.9 million were for professional services costs and $0.5 million were for severance costs. The $2.1 million balance remaining at January 31, 2006 consists of contract termination costs, professional service fees, severance and facilities closure costs.
The Company has performed a preliminary valuation and allocated the total purchase consideration to the assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date, resulting in goodwill of approximately $15.1 million. The Company expects to complete the valuation during its second fiscal quarter. The following table summarizes the preliminary allocation of the purchase price to the fair value of the assets and liabilities acquired.
Approximately $0.8 million of the purchase price represents the estimated fair value of acquired in-process research and development projects that have not yet reached technological feasibility and have no alternative future use. Accordingly, the amount was immediately expensed and included in the statement of operations.
Goodwill and Intangible Assets. Goodwill, representing the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired in the merger, will not be amortized and is not deductible for tax purposes. The purchase price allocated to identifiable intangible assets is as follows:
Amortization of the core/developed technology is included in cost of revenue in the condensed consolidated statement of operations for the three months ended January 31, 2006. The Company included amortization of the other intangible assets in operating expenses in its statement of operations for the three months ended January 31, 2006.
4. GOODWILL AND INTANGIBLE ASSETS
The Companys aggregate goodwill as of January 31, 2006 consisted of the following:
Intangible assets as of January 31, 2006 consisted of the following:
Intangible assets as of October 31, 2005 consisted of the following:
Total amortization expense related to intangible assets is set forth in the table below:
(1) In the three months ended January 31, 2006 $1 million of contingent consideration was paid for intangible assets related to an acquisition of assets on the three months ended January 31, 2005 related to an asset acquisition.
(2) Amortization of capitalized software development is included in cost of license on the statements of operations.
The following table presents the estimated future amortization of intangible assets:
5. STOCK REPURCHASE PROGRAM
The Company is authorized to purchase up to $500 million of its common stock under a stock repurchase program previously established by the Companys Board of Directors (Board) in December 2004. The Company uses all common shares repurchased to offset dilution caused by ongoing stock issuances such as existing employee stock option plans, existing stock purchase plans and acquisitions. During the three months ended January 31, 2006, the Company repurchased approximately 3.9 million shares at an average price of $20.92 per share, for a total of $81.0 million. During the three months ended January 31, 2005, the Company repurchased approximately 2.3 million shares at an average price of $17.11 per share, for a total of $40.2 million. As of January 31, 2006, $355.6 million remained available for repurchases under the program.
6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of:
7. CREDIT FACILITY
In April 2004, Synopsys entered into a three-year, $250.0 million senior unsecured revolving credit facility. This facility contains financial covenants requiring that the Company maintain a minimum leverage ratio and specified levels of cash, as well as other non-financial covenants. The facility terminates on April 28, 2007. Borrowings under the facility bear interest at the greater of the administrative agents prime rate or the federal funds rate plus 0.50%; however, the Company has the option to pay interest based on the outstanding amount at eurodollar rates plus a spread between 0.80% and 1.125% based on a pricing grid tied to a financial covenant. In addition, commitment fees are payable on the facility at rates between 0.20% and 0.25% per annum based on a pricing grid tied to a financial covenant. As of January 31, 2006, the Company had no outstanding borrowings under this credit facility and was in compliance with all covenants.
8. COMPREHENSIVE INCOME
The following table sets forth the components of comprehensive income (loss), net of tax:
(1) See Note 11 for further explanation.
9. NET INCOME (LOSS) PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings per Share, the Company computes basic income (loss) per share by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period (excluding the dilutive effect of stock options and restricted stock). Diluted income per share reflects the dilution of potential common shares outstanding during the period using the treasury stock method. In computing diluted income (loss) per share, using the treasury stock method, the Company adjusts the share count by assuming options are exercised and that the Company repurchases shares with the proceeds of these hypothetical exercises along with the tax benefit resulting from the hypothetical option exercises. The Company further assumes that any unamortized stock based compensation is also used to repurchase shares. For shares issuable under the Employee Stock Purchase Plan, the Company assumes the employee withholdings are used to repurchase shares. In determining the hypothetical shares repurchased, the Company uses the average stock price for the period.
Diluted net income per share excludes anti-dilutive shares and unvested restricted stock totaling 23.9 million and 41.4 million shares, for the three months ended January 31, 2006 and 2005, respectively. While these options and unvested restricted stock are currently anti-dilutive, they could be dilutive in the future. A reconciliation of basic and diluted income per share is presented below:
The table below reconciles the weighted-average common shares used to calculate basic net income per share to the weighted-average common shares used to calculate diluted net income per share.
10. SEGMENT DISCLOSURE
Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, requires disclosures of certain information regarding operating segments, products and services, geographic areas of operation and major customers. SFAS 131 reporting is based upon the management approach. Under this method, management organizes the Companys operating segments for which separate financial information is (i) available and (ii) evaluated regularly by the Chief Operating Decision Maker (CODM) in deciding how to allocate resources and in assessing performance. Synopsys CODMs are the Companys Chief Executive Officer and Chief Operating Officer.
The Company provides software, intellectual property and consulting services to the semiconductor and electronics industries. In making operating decisions, the CODMs primarily consider consolidated financial information, accompanied
by disaggregated information about revenues by geographic region and product platform. The CODMs have determined that the Company operates in a single segment.
Revenue and property and equipment, net, related to operations in the United States and other geographic areas were:
Geographic revenue data for multi-region, multi-product transactions reflect internal allocations and is therefore subject to certain assumptions and to the Companys methodology.
For management reporting purposes, the Company organizes its products and services into five distinct groups: Galaxy Design Platform, Discovery Verification Platform, Intellectual Property, Design for Manufacturing and Professional Service & Other. The Company includes revenue from companies or products it has acquired during the periods covered from the acquisition date through the end of the relevant periods. For presentation purposes, the Company allocates software maintenance revenue to the products to which those support services relate.
One customer accounted for more than ten percent of the Companys consolidated revenue in the three months ended January 31, 2006 and 2005 (See Note 13).
11. OTHER INCOME, NET (EXPENSE)
The following table presents a summary of other income (expense) components:
(1) For the three months ended January 31, 2006, this amount consists primarily of $0.8 million in premiums paid on foreign exchange forward contracts.
In the first quarter of fiscal 2005, the Company reevaluated its interpretation of certain provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivatives and Hedging (SFAS 133), resulting in the discovery of an error in the application of the standard to certain prior year foreign currency hedge transactions. The effect of the error was not material in any prior period and did not impact the economics of the Companys hedging program. To correct the error, the Company reclassified the remaining $3.0 million related to the disallowed hedges from accumulated other comprehensive loss to other income in the three months ended January 31, 2005.
Effective Tax Rate. The Company estimates its annual effective tax rate at the end of each quarterly period. The Companys estimate takes into account estimates of annual pre-tax income (and losses), the geographic mix of pre-tax income (and losses) and our interpretations of tax laws and possible outcomes of current and future audits.
The Companys effective tax rate for the three months ended January 31, 2006 and 2005 was a tax expense rate of 43.9% and a tax benefit rate of 25.2% respectively. The provision for income taxes for the three months ended January 31, 2006 includes a tax expense of $100,000 relating to foreign taxes which was treated as a discrete event allocable to the quarter.
In November 2005, FASB issued Financial Statement Position (FSP) on FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Effective upon issuance, this FSP describes an alternative transition method for calculating the tax effects of stock based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock based compensation, and to determine the subsequent impact on the APIC pool and the statement of cash flows of the tax effects of employee stock based compensation awards that are outstanding upon adoption of SFAS 123(R). Companies have one year from the later of the adoption of SFAS 123(R) or the effective date of the FSP to evaluate their transition alternatives and make a one-time election. The Company is evaluating which transition method to adopt and the potential impact of this new guidance on its results of operations and financial position.
IRS Revenue Agents Report. On May 31, 2005, the Company received a Notice of Proposed Adjustment from the Internal Revenue Service (IRS) asserting a very large net increase to its U.S. taxable income arising from the audit of fiscal years 2000 and 2001. On June 8, 2005, the Company received a Revenue Agents Report (RAR) in which the IRS proposed to assess a net tax deficiency for fiscal years 2000 and 2001 of approximately $476.8 million, plus interest. Interest accrues on the amount of any deficiency finally determined until paid, and compounds daily at the federal underpayment rate, which adjusts quarterly. A higher underpayment rate of interest may be charged as a result of the issuance of the RAR.
This proposed adjustment primarily relates to transfer pricing transactions between the Company and a wholly-owned foreign subsidiary. The proposed adjustment for fiscal years 2000 and 2001 is the total amount relating to these transactions asserted under the IRS theories.
On July 13, 2005, the Company filed a protest to the proposed deficiency with the IRS, which caused the matter to be referred to the Appeals Office of the IRS. Resolution of this matter could take a considerable time, possibly years. The Company strongly believes the proposed IRS adjustments and resulting proposed deficiency are inconsistent with applicable
tax laws, and that the Company thus has meritorious defenses to these proposals. Accordingly, the Company will continue to challenge these proposed adjustments vigorously. While it believes the IRS asserted adjustments are not supported by applicable law, the Company believes it is probable it will be required to make additional payments in order to resolve this matter. However, based on the Companys analysis to date, the Company believes it has adequately provided for this matter. If the Company is required to pay a significant amount of additional U.S. taxes and applicable interest in excess of its provision for this matter, its results of operations and financial condition could be materially and adversely affected.
13. RELATED PARTY TRANSACTIONS
Andy D. Bryant, Intel Corporations Executive Vice President and Chief Financial and Enterprise Services Officer, served on the Companys Board of Directors from January 1999 to May 2005. Revenue derived from Intel Corporation and its subsidiaries in the aggregate accounted for approximately 12% of the Companys total revenue for the three months ended January 31, 2006 and 13% of the Companys total revenue for the three months ended January 31, 2005. Management believes all transactions between the two parties were carried out on an arms length basis.
In connection with the Companys December 1, 2004 announcement that it had signed agreements to acquire Nassda Corporation (Nassda) and to settle all outstanding litigation between the two companies, a class action complaint entitled Robert Israel v. Nassda Corporation, et. al., No. 4705695, was filed in the Court of Chancery of the State of Delaware naming Nassda, its directors and Synopsys as defendants. The complaint purported to be a class action lawsuit brought on behalf of shareholders of Nassda, other than the defendant directors and their affiliates, who allegedly would be injured or threatened with injury if the proposed acquisition of Nassda by Synopsys proceeded forward on the terms announced. A class action complaint alleging substantially the same facts was also filed in California Superior Court. The purported class actions sought to enjoin the transaction or, alternatively, unspecified damages. In May 2005, Synopsys completed its acquisition of Nassda. In October, 2005, the Chancery Court approved a settlement of the Delaware action by which Synopsys would pay an aggregate of $0.15 per share to each former shareholder of Nassda (other than the defendant directors and their affiliates), for a total of approximately $1.8 million, and would pay certain fees and expenses of plaintiffs counsel. In December 2005, the plaintiffs in the Delaware action dismissed their complaint with prejudice and Synopsys paid the agreed-upon amounts. The California action was also dismissed with prejudice in December 2005, with each party bearing its own costs.
The following discussion of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Item 1 of this report. This discussion contains forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth under the caption Factors That May Affect Future Results. The words may, will, could, would, anticipate, expect, intend, believe, continue, or the negatives of such terms, or other comparable terminology and similar expressions identify these forward-looking statements. The information included herein is as of the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC); future events or circumstances could differ significantly from these forward-looking statements. Accordingly, we caution readers not to place undue reliance on these statements.
Synopsys, Inc. (Synopsys) is a world leader in electronic design automation (EDA) software and related services for semiconductor design. We deliver technology-leading semiconductor design and verification software platforms and integrated circuit (IC) manufacturing software products to the global electronics market, enabling the development and production of complex systems-on-chips (SoCs). In addition, we provide intellectual property (IP) and design services to simplify the design process, and accelerate time-to-market for our customers. We also provide software and services that help customers prepare and optimize their designs for manufacturing.
We generate substantially all of our revenue from customers in the semiconductor and electronics industries. Our customers typically fund purchases of our software and services largely out of their research and development (R&D) budgets and, to a lesser extent, their manufacturing and capital budgets. As a result, our customers business outlook and willingness to invest in new and increasingly complex chip designs heavily influence our business.
Since the 2000 through 2002 semiconductor downturn and subsequent recovery, our customers have focused significantly on expense reductions, including in their R&D budgets. This expense outlook has affected us in a number of ways. First, some customers have reduced their overall level of EDA expenditures by decreasing their level of EDA tool purchases, using older generations of product, or not renewing maintenance services. Second, customers, bargain more intensely on pricing and payment terms, which has affected revenues industry-wide. For example, reduced demand for up-front licenses, and customers desire to conserve cash by paying for licenses over time resulted in a shift of our license mix to an almost completely ratable model on the fourth quarter of fiscal 2004, in which substantially more revenue is recognized over time rather than at the time of shipment. This shift adversely affected our total revenue in fiscal 2004 and 2005. Third, customers are beginning to seek to consolidate their EDA purchases with fewer suppliers in order to lower their overall cost of ownership, while at the same time meeting new technology challenges. This has increased competition among EDA vendors.
Over the long term, we believe EDA industry spending growth will continue to depend on growth in semiconductor R&D spending and on continued growth in the overall semiconductor market. The Semiconductor Industry Association has forecasted modest growth in semiconductor revenues in 2006 and we believe semiconductor R&D spending will grow similarly during 2006. However, we cannot currently predict whether this outlook will contribute to higher R&D spending and/or to higher EDA industry spending. If EDA industry spending increases, we believe we are well positioned to capitalize on such increases. Further, recognizing that our customers will continue to spend cautiously and aggressively contain costs, we are intensely focused on improving our customers overall economics of design by providing more fully-integrated design solutions and offering customers the opportunity to consolidate their EDA spending with us.
We are under no obligation (and expressly disclaim any such obligation) to update or alter any of the information contained in this Overview, whether as a result of new information, future events or otherwise, except to the extent required by law.
Product Developments for the Three Months Ended January 31, 2006
During the first quarter of fiscal 2006, we announced or introduced a number of new products and related developments, including:
Availability of a new 90 nanometer low-power system-on-chip reference design flow for fabrication on a leading global semiconductor foundrys process.
Expansion of our DesignWare® mixed-signal IP to include application-specific memory input/output libraries to help enable development of interfaces for mobile product applications.
Our DesignWare digital controller IP for PCI Express becoming the first to support the 2.0 version of the PCI Express specification, enabling increased bandwidth in networking, embedded and computer applications.
Financial Performance for the Three Months Ended January 31, 2006
Revenue was $260.2 million, up 8% from $241.3 million in the first quarter of fiscal 2005, primarily reflecting our fourth quarter fiscal 2004 license model shift, which has resulted in increases in time-based revenue which more than offset decreases in upfront and service revenue during the current quarter.
Time-based license revenue increased 13% from $186.3 million in the first quarter of fiscal 2005 to $211.1 million in the current quarter, primarily reflecting the continued phase-in of our license model shift as time-based orders booked in prior periods contribute revenue to current and future periods.
Upfront license revenue declined 22% from $10.8 million in the first quarter of fiscal 2005 to $8.4 million in the current quarter, reflecting our license model shift.
We derived approximately 4% of our software license revenue from upfront licenses and 96% from time-based licenses in the current quarter, versus approximately 5% and 95%, respectively, in the same quarter last year, reflecting our license model shift.
Maintenance revenue declined by 19% from $36.2 million in the first quarter of fiscal 2005 to $29.3 million in the current quarter, primarily as a result of the shift to a more ratable license model (which reduces new maintenance orders since maintenance is included with the license fee in time-based licenses and not billed separately), and, to a lesser extent, by non-renewal of maintenance by some of our existing perpetual license customers. Professional service and other revenue, at $11.4 million, increased 43% from $8.0 million in the first quarter of fiscal 2005 due to the timing of customer acceptance of services performed under ongoing contracts and continued full utilization of our services capacity.
Net income was $1.7 million compared to net loss of $(14.3) million in the first quarter of fiscal 2005, primarily due to increased revenue, reduced cost of goods sold due to reduced amortization of intangible assets from acquisitions, reduced sales and marketing expenses driven by shipments, and a reduced in-process research and development charges compared to the prior period, partially offset by increased research and development expense caused by acquisitions and commencement of recognition of stock-based compensation expense, in accordance with SFAS No. 123(R).
Net cash provided by operations decreased 86% from $142.1 million in the first quarter of fiscal 2005 to $19.8 million, primarily as a result of increased vendor and bonus and commission payments and a decrease in cash collections compared to the same period in fiscal 2005.
We repurchased approximately 3.9 million shares of our common stock at an average price of $20.92 per share for approximately $81.0 million.
Acquisitions in the Three Months Ended January 31, 2006
During the quarter, we completed our acquisition of HPL Technologies, Inc. for a cash purchase price of $0.30 per share and total gross payments of $12.9 million, which will help solidify Synopsys position as a leading EDA vendor in design for manufacturing (DFM) software and will give Synopsys a comprehensive design-to-silicon flow that links directly into the semiconductor manufacturing process. See Note 3 to Notes to Unaudited Condensed Consolidated Financial Statements.
Critical Accounting Policies and Estimates
The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires our management to make judgments and estimates that affect the amounts reported in our financial statements and accompanying notes. Our management believes that we consistently apply these judgments and estimates and the financial statements and accompanying notes fairly represent all periods presented. However, any differences between these judgments and estimates and actual results could have a material impact on our
statement of operations and financial condition. Critical accounting policies and estimates, as defined by the Securities and Exchange Commission (SEC), are those that are most important to the portrayal of our financial condition and results of operations and require our managements most difficult and subjective judgments and estimates of matters that are inherently uncertain. Our critical accounting policies and estimates include those regarding (1) revenue recognition; (2) valuation of intangible assets and goodwill; (3) income taxes and; (4) stock-based compensation. We describe our revenue recognition and stock-based compensation policies below. Our remaining critical accounting policies and estimates are discussed in Part II, Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations of our annual report on Form 10-K for the fiscal year ended October 31, 2005, filed with the SEC on January 12, 2006.
Revenue Recognition. Synopsys recognizes revenue from software licenses and maintenance and service revenue. Software license revenue consists of fees associated with the licensing of Synopsys software. Maintenance and service revenue consists of maintenance fees associated with perpetual and term licenses and professional service fees.
Synopsys has designed and implemented revenue recognition policies in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.
With respect to software licenses, Synopsys utilizes three license types:
Technology Subscription Licenses (TSLs) are for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. We bundle and do not charge separately for post-contract customer support (maintenance) for the term of the license.
Term licenses are also for a finite term, but do not provide the customer any rights to receive, or to exchange licensed software for unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually for the balance of the term. The annual maintenance fee is typically calculated as a percentage of the net license fee.
Perpetual licenses continue as long as the customer renews maintenance, plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually.
For the three software license types, we recognize revenue as follows:
Technology Subscription Licenses. Synopsys typically recognizes revenue from TSL license fees (which include bundled maintenance) ratably over the term of the license period, or, if later, as customer installments become due and payable. All TSLs are reported as time-based licenses.
Term Licenses. Synopsys recognizes the term license fee in full upon shipment of the software if payment terms require the customer to pay at least 75% of the term license fee within one year from shipment and all other revenue recognition criteria are met. Such term licenses are reported as upfront licenses. For term licenses where less than 75% of the term license fee is due within one year from shipment, Synopsys recognizes revenue as customer installments become due and payable. Due and payable term licenses are reported as time-based licenses.
Perpetual Licenses. Synopsys recognizes the perpetual license fee in full upon shipment of the software if payment terms require the customer to pay at least 75% of the perpetual license fee within one year from shipment and all other revenue recognition criteria are met. Such perpetual licenses are reported as upfront licenses. For perpetual licenses in which less than 75% of the license fee is payable within one year from shipment, we recognize the revenue as customer installments become due and payable. Such perpetual licenses are reported as time-based licenses.
Synopsys allocates revenue on software transactions (referred to as arrangements) involving multiple elements to each element based on the relative fair values of the elements. Our determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE for each element to the price charged when the same element is sold separately.
We have analyzed all of the elements included in our multiple-element arrangements and have determined that we have sufficient VSOE to allocate revenue to the maintenance components of our perpetual and term license products and to consulting. Accordingly, assuming all other revenue recognition criteria are met, we recognize revenue from perpetual and
term licenses upon delivery using the residual method in accordance with SOP 98-9, we recognize revenue from maintenance ratably over the maintenance term, and we recognize revenue from consulting services as the related services are performed and accepted.
Synopsys makes significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) its fee is fixed or determinable, and (iv) collectibility is probable. We apply these criteria as discussed below.
Persuasive Evidence of an Arrangement Exists. Prior to recognizing revenue on an arrangement, our customary policy is to have a written contract, signed by both the customer and Synopsys or a purchase order from those customers that have previously negotiated a standard end-user license arrangement or volume purchase agreement.
Delivery Has Occurred. We deliver software to our customers physically or electronically. For physical deliveries, the standard transfer terms are typically FOB shipping point. For electronic deliveries, delivery occurs when we provide the customer access codes, or keys, that allow the customer to take immediate possession of the software on its hardware.
The Fee is Fixed or Determinable. Our determination that an arrangement fee is fixed or determinable depends principally on the arrangements payment terms. Our standard payment terms require 75% or more of the arrangement fee to be paid within one year. Where these terms apply, we regard the fee as fixed or determinable, and recognize revenue upon delivery (assuming all other revenue recognition criteria are met). If the payment terms do not meet this standard, which we refer to as extended payment terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable. In the case of a TSL, we recognize revenue ratably even if the fee is fixed or determinable, due to the fact that maintenance services are included with the software license and due to guidelines relating to arrangements that include rights to receive unspecified future technology.
Collectibility is Probable. To recognize revenue, we must judge collectibility of the arrangement fees, which we do on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers with whom we have a history of successful collection. For a new customer or where an existing customer substantially expands its commitments to us, we evaluate the customers financial position and ability to pay and typically assign a credit limit based on that review. We increase the credit limit only after we have established a successful collection history with the customer. If we determine at any time that collectibility is not probable based upon its credit review process or the customers payment history, we recognize revenue on a cash-collected basis.
We recognize maintenance and service revenue as follows:
Maintenance Fees Associated with Perpetual and Term Licenses. Synopsys recognizes revenue from maintenance associated with perpetual and term licenses ratably over the maintenance term.
Professional Service Fees. Synopsys recognizes revenue from consulting and training services as services are performed and accepted.
Valuation of Stock-Based Compensation. Effective November 1, 2005, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R) establishes standards for accounting for transactions in which an entity exchanges its equity instruments, such as stock options, for goods or services, such as the services of the entitys employees. SFAS 123(R) also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by the issuance of those equity instruments. SFAS 123(R) eliminates the ability to account for stock-based compensation transaction using the intrinsic value method under APB 25 and generally requires instead that such transactions be accounted for using a fair-value based method. Accordingly, we measure stock-based compensation cost at the grant date, based on the fair value of the award, and recognize the expense over the employees requisite service period using the modified prospective method. The measurement of stock-based compensation cost is based on several criteria including, but not limited to, the valuation model used and associated input factors such as expected term of the award, stock price volatility, dividend rate, risk free interest rate, and award cancellation rate. The input factors to use in the valuation model are based on subjective future expectations combined with management judgment. If there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation costs. These changes may materially impact our results of operations in the period such change are made.
Results of Operations
We generate our revenue from the sale of software licenses, maintenance and professional services. Under current accounting rules and policies applicable to different kinds of license arrangements, we recognize revenue from orders we receive for software licenses and services at varying times. In general, we recognize revenue on a time-based software license order over the license term and on an upfront term or perpetual software license order at the time the license is shipped. Substantially all of our current time-based licenses are technology subscription licenses, or TSLs, with an average license term of approximately three years. Maintenance orders generally generate revenue ratably over the maintenance period (generally one year). Professional service orders generally generate revenue upon completion and customer acceptance of contractually agreed milestones. A more complete description of our revenue recognition policy can be found above under Critical Accounting Policies and Estimates.
Our revenue in any fiscal quarter is equal to the sum of our time-based license, upfront license, maintenance and professional service revenue for such period. We derive time-based license revenue in any quarter almost entirely from TSL orders received and delivered in prior quarters. We derive upfront license revenue directly from upfront license orders booked and shipped during the quarter. We derive maintenance revenue in any quarter largely from maintenance orders received in prior quarters since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional service revenue almost entirely from orders received in prior quarters, since we recognize revenue from professional services when those services are delivered and accepted, not when they are booked.
Our license revenue is very sensitive to the mix of time-based and upfront licenses delivered during the quarter. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL shipped on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the twelve succeeding quarters. Conversely, upfront licenses generate higher current quarter revenue but no future revenue (e.g., a $120,000 order for an upfront license generates $120,000 in revenue in the quarter the product is shipped, but no future revenue). TSLs also result in a shift of maintenance revenue to time-based license revenue since maintenance is included in TSLs, while maintenance on upfront orders is charged and reported separately.
License Order Mix
The percentage of upfront licenses we book is driven by a number of factors, including the level of overall license orders, customer demand, preferred customer payment terms and customer-requested ship dates. Prior to August 2000, substantially all of our license revenue was upfront. Beginning in August 2000, when we introduced TSLs, we shifted our target license order mix to approximately 75% TSLs and 25% upfront licenses, based on our expectations of total orders and our assessment of the demand for upfront licenses. We substantially maintained this mix from this date through fiscal 2003. However, as a result of reduced customer demand for upfront licenses as noted above in Business Environment, we shifted to an almost completely time-based license model in the fourth quarter of fiscal 2004. Our actual license order mix for the last nine fiscal quarters is set forth below.
In certain cases, our time-based and upfront term license agreements provide the customer the right to re-mix a portion of the software initially licensed for other specified Synopsys products. The customers re-mix of product, when allowed under the license arrangement, does not alter the timing of recognition of the license fees paid by the customer. Because in such cases the customer does not need to obtain a new license and pay additional license fees to use the additional products, these arrangements could result in reduced revenue compared to licensing the individual products separately. However, we believe providing our customers re-mix rights can also assist in broader adoption of our products.
The increase in total revenue for the first quarter of fiscal 2006 compared to the same quarter of fiscal 2005 was due primarily to the change in the fourth quarter of fiscal 2004 in our license model to an almost completely ratable model which increased ratable license bookings that are recognized as revenue in future periods and to increased business levels.
Time-Based License Revenue
The increase in time-based license revenue in the first quarter of fiscal 2006 compared to the same quarter in fiscal 2005 was primarily due to the license model shift under which previously booked orders continue to contribute to revenue in later periods.
Upfront License Revenue
The decrease in upfront license revenue was due primarily to changes in customer mix which can drive changes in the amount of upfront orders in a particular quarter.
Unfilled upfront license orders were approximately $4.8 million at January 31, 2006 compared to $6.6 million as of January 31, 2005. Unfilled upfront license orders represent non-cancelable license orders received from our customers prior to the end of the fiscal quarter but not shipped as of the end of such period. We generally ship our software products promptly after acceptance of customer orders. However, a number of factors can affect the timing of product shipments and, as a result, timing of revenue recognition, including the delivery dates requested by customers, the effect of the related license revenue on our business plan and our operational capacity to fulfill upfront software license orders at the end of a quarter.
Maintenance and Service Revenue
Our maintenance revenue has declined due to (i) our continued shift towards TSLs, which include maintenance with the license fee and thus generate no separately recognized maintenance revenue, (ii) generally lower maintenance rates on larger perpetual license transactions, and (iii) to a lesser extent, non-renewal of maintenance by certain customers on perpetual or other upfront licenses. With our license model shift, we expect progressively more of our maintenance revenue to be included in TSL revenue, and therefore for our separately recognized maintenance revenue to continue to decline. In addition, some customers may choose in the future not to renew maintenance on upfront licenses for economic or other factors, which would also adversely affect future maintenance revenue.
Professional service and other revenue increased in the first quarter of fiscal 2006 compared to the same period in fiscal 2005 and 2004 due principally to timing of customer acceptance of services performed under ongoing contracts.
RevenueProduct Groups. For management reporting purposes, we organize our products and services into five groups: Galaxy Design Platform, Discovery Verification Platform, Intellectual Property, Design for Manufacturing, and Professional Services & Other.
Galaxy Design Platform. Our Galaxy Design Platform provides our customers a single, integrated IC design solution which incorporates common libraries and consistent timing, delay calculation and constraints throughout the design process. The principal products in the Galaxy platform are the IC Compiler physical design solution, Design Compiler® logic synthesis product, Physical Compiler® physical synthesis product, Apollo physical design product, Astro advanced physical design system, PrimeTime®/PrimeTime® SI timing analysis products, Formality® formal verification sign-off solution, Star RXCTÔ extraction solution and Hercules physical verification family.
Discovery Verification Platform. Our Discovery Verification Platform combines our simulation and verification products and design-for-verification methodologies, and provides a consistent control environment to improve the speed, breadth and accuracy of our customers verification efforts. The principal products in the Discovery platform are the VCS® comprehensive RTL verification solution, Vera® testbench generator, NanoSim® FastSPICE circuit simulation product, HSPICE® circuit simulator, our reusable verification IP and our Discovery AMS mixed-signal verification solution.
Intellectual Property. Our IP solutions include our DesignWare® Foundation Library of basic chip elements, DesignWare Verification Library of popular chip function models and DesignWare Cores, pre-designed and pre-verified digital and mixed-signal design blocks that implement many of the most important industry standards, including USB (1.1, 2.0 and On-the-Go), PCI (PCI, PCI-X and PCI-Express), Serial ATA, Ethernet and JPEG.
Design for Manufacturing. Our Design for Manufacturing products and technologies address the mask-making, yield enhancement and test chip challenges of very small geometry ICs and include our TCAD device modeling products, Proteus OPC /InPhase optical proximity correction products, phase-shift masking technologies, SiVL® layout verification product, CATS® mask data preparation product and Virtual Stepper® mask qualification product.
Professional Services & Other. Our Professional Services group provides consulting services, including design methodology assistance, specialized systems design services, turnkey design and training.
The following table summarizes the revenue attributable to these groups as a percentage of total revenue for the last eight quarters. We include revenue from companies or products we have acquired during the periods covered from the acquisition date through the end of the relevant periods. For presentation purposes, we allocate maintenance revenue, which represented approximately 11% and 15% of our total revenue for the three months ended January 31, 2006 and 2005, respectively, to the products to which those support services related.