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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-19807
----------------
SYNOPSYS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1546236
------------------------------ ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
700 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(Address of principal executive offices)
TELEPHONE: (650) 584-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13, or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
75,639,019 shares of Common Stock as of September 6, 2002
SYNOPSYS, INC.
QUARTERLY REPORT ON FORM 10-Q
JULY 31, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.................................................3
CONDENSED CONSOLIDATED BALANCE SHEETS................................3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS............4
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS.........................................................5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.........................................18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK...........38
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...................................................39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS..................44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................45
SIGNATURES....................................................................45
2
PART I
ITEM 1. FINANCIAL STATEMENTS
SYNOPSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
JULY 31, OCTOBER 31,
2002 2001
---------------- -----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 347,661 $ 271,696
Short-term investments 98,547 204,740
---------------- -----------------
Total cash and short-term investments 446,208 476,436
Accounts receivable, net of allowances of $22,985 and
$11,027, respectively 233,157 146,294
Deferred tax assets 169,208 149,239
Prepaid expenses and other 54,973 19,413
---------------- -----------------
Total current assets 903,546 791,382
Property and equipment, net 185,872 192,304
Long-term investments 48,767 61,699
Goodwill, net 368,068 35,077
Intangible assets, net 351,249 3,197
Restricted asset 240,000 --
Other assets 61,503 45,248
---------------- -----------------
Total assets $ 2,159,005 $ 1,128,907
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 233,756 $ 135,272
Current portion of long-term debt 178 535
Accrued income taxes 123,338 110,561
Deferred revenue 379,897 290,052
---------------- -----------------
Total current liabilities 737,169 536,420
Deferred compensation and other long-term liabilities 50,400 17,124
Long-term deferred revenue 63,167 89,707
Stockholders' equity:
Preferred stock, $.01 par value; 2,000 shares authorized; no shares
outstanding -- --
Common stock, $.01 par value; 400,000 shares authorized; 76,105 and
59,428 shares outstanding, respectively 761 595
Additional paid-in capital 1,031,183 575,403
Retained earnings 303,755 436,662
Treasury stock, at cost (9,875) (531,117)
Deferred stock compensation (7,592) --
Accumulated other comprehensive income (9,963) 4,113
---------------- -----------------
Total stockholders' equity 1,308,269 485,656
---------------- -----------------
Total liabilities and stockholders' equity $ 2,159,005 $ 1,128,907
================ =================
The accompanying notes are an integral part of these financial statements.
3
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
----------------- ----------------- ----------------- -----------------
Revenue:
Product $ 60,096 $ 44,858 $ 151,944 $ 117,152
Service 73,924 81,430 208,782 259,900
Ratable license 102,075 49,822 236,552 119,736
----------------- ----------------- ----------------- -----------------
Total revenue 236,095 176,110 597,278 496,788
----------------- ----------------- ----------------- -----------------
Cost of revenue:
Product 4,400 6,086 11,687 17,616
Service 19,819 19,158 57,894 58,427
Ratable license 10,101 7,476 34,321 19,689
Amortization of intangible assets and
deferred stock compensation 13,366 - 13,366 -
----------------- ----------------- ----------------- -----------------
Total cost of revenue 47,686 32,720 117,268 95,732
----------------- ----------------- ----------------- -----------------
Gross margin 188,409 143,390 480,010 401,056
Operating expenses:
Research and development 61,581 49,382 156,936 143,239
Sales and marketing 69,122 68,954 192,122 207,735
General and administrative 21,908 19,140 58,153 50,933
Integration 117,266 - 117,266 -
In-process research and development 82,500 - 82,500 -
Amortization of intangible assets and deferred stock
compensation 8,820 4,163 17,220 12,514
----------------- ----------------- ----------------- -----------------
Total operating expenses 361,197 141,639 624,197 414,421
----------------- ----------------- ----------------- -----------------
Operating (loss) income (172,788) 1,751 (144,187) (13,365)
Other income, net 11,408 19,499 33,702 66,901
----------------- ----------------- ----------------- -----------------
(Loss) income before (benefit) provision for income (161,380) 21,250 (110,485) 53,536
taxes
(Benefit) provision for income taxes (23,791) 6,800 (8,328) 17,132
----------------- ----------------- ----------------- -----------------
Net (loss) income $ (137,589) $ 14,450 $ (102,157) $ 36,404
================= ================= ================= =================
Basic (loss) earnings per share $ (1.93) $ 0.24 $ (1.59) $ 0.60
================= ================= ================= =================
Weighted average common shares outstanding 71,157 60,048 64,157 61,050
================= ================= ================= =================
Diluted (loss) earnings per share $ (1.93) $ 0.22 $ (1.59) $ 0.56
================= ================= ================= =================
Weighted average common shares
and dilutive stock options outstanding 71,157 64,887 64,157 65,362
================= ================= ================= =================
The accompanying notes are an integral part of these financial statements.
4
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
NINE MONTHS ENDED
JULY 31,
----------------------------------
2002 2001
---------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (102,157) $ 36,404
Adjustments to reconcile net (loss) income to net cash flows (used in)
provided by operating activities:
In-process research and development 82,500 --
Depreciation and amortization 69,835 48,149
Tax benefit associated with stock options 18,001 14,603
Impairment of land and buildings 14,712 --
Impairment of long-term investments 7,539 4,348
Provision for doubtful accounts and sales returns 3,065 2,237
Deferred taxes (3,967) --
Gain on sale of long-term investments (21,393) (43,128)
Gain on sale of silicon libraries business -- (10,580)
Other 2,538 306
Net changes in operating assets and liabilities:
Accounts receivable (22,774) 12,491
Prepaid expenses and other current assets 1,079 (2,366)
Other assets (7,323) (414)
Accounts payable and accrued liabilities (75,978) (22,008)
Accrued income taxes (81,799) (19,614)
Deferred revenue 33,225 100,153
Deferred compensation 4,748 2,781
---------------- -----------------
Net cash (used in) provided by operating activities (78,149) 123,362
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of contingently refundable insurance policy (240,000) --
Cash acquired in the Avant! acquisition 234,963 --
Purchases of property and equipment (35,902) (51,980)
Purchases of short-term investments (667,430) (1,656,744)
Proceeds from sales and maturities of short-term investments 778,501 1,764,892
Purchases of long-term investments (5,205) (11,000)
Proceeds from sale of long-term investments 30,533 62,446
Proceeds from the sale of silicon libraries business -- 4,122
Purchase of intangible assets, net -- (166)
Capitalization of software development costs (1,194) (750)
---------------- -----------------
Net cash provided by investing activities 94,266 110,820
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations -- (6,468)
Issuances of common stock 103,595 89,310
Purchases of treasury stock (41,773) (331,878)
---------------- -----------------
Net cash provided by (used in) financing activities 61,822 (249,036)
Effect of exchange rate changes on cash (1,974) (3,762)
---------------- -----------------
Net increase (decrease) in cash and cash equivalents 75,965 (18,616)
Cash and cash equivalents, beginning of period 271,696 153,120
---------------- -----------------
Cash and cash equivalents, end of period $ 347,661 $ 134,504
================ =================
SUPPLEMENTAL NONCASH DISCLOSURES:
Issuance of stock and options in exchange for net assets of Avant! $ 858,421 $ --
The accompanying notes are an integral part of these financial statements.
5
SYNOPSYS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF COMPANY AND BASIS OF PRESENTATION
Synopsys, Inc. (Synopsys or the Company) is a leading supplier of electronic
design automation (EDA) software to the global electronics industry. The Company
develops, markets, and supports a wide range of integrated circuit (IC) design
products that are used by designers of advanced ICs and the electronic systems
(such as computers, cell phones, and internet routers) that use such ICs to
automate significant portions of their IC design process. ICs are distinguished
by the speed at which they run, their area, the amount of power they consume and
their cost of production. Synopsys' products offer its customers the opportunity
to design ICs that are optimized for speed, area, power consumption and
production cost, while reducing overall design time. The Company also provides
consulting services to help its customers improve their IC design processes and
to assist them with their IC designs, as well as training and support services.
The Company's fiscal year ends on the Saturday nearest October 31. Fiscal
year 2001 was a 53-week year, with the extra week added to the first quarter,
and fiscal year 2002 will be a 52-week year. For presentation purposes, the
unaudited condensed consolidated financial statements and notes refer to the
calendar month end.
On June 6, 2002 (the "closing date"), the Company completed its merger with
Avant! Corporation (Avant!), a company that develops, markets, licenses and
supports electronic design automation software products that assist design
engineers in the physical layout, design, verification, simulation, timing and
analysis of advanced integrated circuits. Under the terms of the merger
agreement between the Company and Avant!, Avant! merged with and into a wholly
owned subsidiary of Synopsys. The merger is accounted for under the purchase
method of accounting. The results of operations of Avant! are included in the
accompanying condensed consolidated financial statements for the period from the
closing date through July 31, 2002.
The unaudited condensed consolidated financial statements include the
accounts of Synopsys and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the financial position and results of
operations of the Company have been made. Operating results for the interim
periods are not necessarily indicative of the results that may be expected for
any future period or the full fiscal year. The unaudited condensed consolidated
financial statements and notes included herein should be read in conjunction
with the consolidated financial statements and notes thereto for the fiscal year
ended October 31, 2001 included in the Company's 2001 Annual Report on Form
10-K.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the unaudited condensed
consolidated financial statements and accompanying notes. A change in the facts
and circumstances surrounding these estimates and assumptions could result in a
change to the estimates and assumptions and impact future operating results.
2. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION AND COST OF REVENUE
Revenue consists of fees for perpetual and time-based licenses for the
Company's software products, sales of hardware system products, post-contract
customer support (PCS), customer training and consulting. The Company classifies
its revenues as product, service or ratable license. Product revenue consists
primarily of sales of perpetual licenses.
Service revenue consists of fees for consulting services, training, and PCS
associated with non-ratable time-based licenses or perpetual licenses. PCS sold
with perpetual licenses is generally renewable, after any bundled PCS period
expires, in one-year increments for a fixed percentage of the perpetual list
price or, for perpetual license arrangements in excess of $2 million, as a
percentage of the net license fee.
Ratable license revenue is all fees related to time-based licenses bundled
with PCS and sold as a single package (commonly referred to by the Company as a
Technology Subscription License or TSL), and time-based licenses on which the
Company has granted extended payment terms or under which the customer has a
right to receive unspecified future products.
6
Cost of product revenue includes cost of production personnel, product
packaging, documentation, amortization of capitalized software development
costs, and costs of the Company's systems products. Cost of service revenue
includes personnel and the related costs associated with providing training,
consulting and PCS. Cost of ratable license revenue includes the cost of
products and services related to time-based licenses bundled with PCS and sold
as a single package and to time-based licenses that include extended payment
terms or unspecified additional products. Cost of revenue also includes the
amortization of the contract rights intangible, core technology and deferred
compensation.
The Company recognizes revenue in accordance with SOP 97-2, SOFTWARE REVENUE
RECOGNITION, as amended by SOP 98-9 and SOP 98-4, and generally recognizes
revenue when all of the following criteria are met as set forth in paragraph 8
of SOP 97-2:
o Persuasive evidence of an arrangement exists,
o Delivery has occurred,
o The vendor's fee is fixed or determinable, and
o Collectibility is probable.
The Company defines each of the four criteria above as follows:
PERSUASIVE EVIDENCE OF AN ARRANGEMENT EXISTS. It is the Company's customary
practice to have a written contract, which is signed by both the customer
and Synopsys, or a purchase order from those customers that have previously
negotiated a standard end-user license arrangement or volume purchase
agreement, prior to recognizing revenue on an arrangement.
DELIVERY HAS OCCURRED. The Company's software may be either physically or
electronically delivered to its customers. For those products that are
delivered physically, the Company's standard transfer terms are FOB shipping
point. For an electronic delivery of software, delivery is considered to
have occurred when the customer has been provided with the access codes that
allow the customer to take immediate possession of the software on its
hardware.
If an arrangement includes undelivered products or services that are
essential to the functionality of the delivered product, delivery is not
considered to have occurred.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. The fee the Company's customers
pay for its products is negotiated at the outset of an arrangement, and is
generally based on the specific volume of products to be delivered. The
Company's license fees are not a function of variable-pricing mechanisms
such as the number of units distributed or copied by the customer, or the
expected number of users in an arrangement. Therefore, except in cases where
the Company grants extended payment terms to a specific customer, the
Company's fees are considered to be fixed or determinable at the inception
of its arrangements.
The Company's customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. Arrangements with payment
terms extending beyond the customary payment terms are considered not to be
fixed or determinable. Revenue from such arrangements is recognized at the
lesser of the aggregate of amounts due and payable or the amount of the
arrangement fee that would have been recognized if the fees had been fixed
or determinable.
COLLECTIBILITY IS PROBABLE. Collectibility is assessed on a
customer-by-customer basis. The Company typically sells to customers for
which there is a history of successful collection. New customers are
subjected to a credit review process, which evaluates the customers'
financial positions and, ultimately, their ability to pay. New customers are
typically assigned a credit limit based on a formulated review of their
financial position. Such credit limits are only increased after a successful
collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not
probable based upon the Company's credit review process, revenue is
recognized on a cash-collected basis.
MULTIPLE-ELEMENT ARRANGEMENTS. The Company allocates revenue on software
arrangements involving multiple elements to each element based on the relative
fair values of the elements. The Company's determination of fair value of each
element in multiple-element arrangements is based on vendor-specific objective
evidence (VSOE). The Company limits its assessment of VSOE for each element to
the price charged when the same element is sold separately.
7
The Company has analyzed all of the elements included in its
multiple-element arrangements and determined that it has sufficient VSOE to
allocate revenue to the PCS components of its perpetual license products and
consulting. Accordingly, assuming all other revenue recognition criteria are
met, revenue from perpetual licenses is recognized upon delivery using the
residual method in accordance with SOP 98-9, and revenue from PCS is recognized
ratably over the PCS term. The Company recognizes revenue from TSLs over the
term of the ratable license period, as the license and PCS portions of a TSL are
bundled and not sold separately. Revenue from contracts with extended payment
terms is recognized as the lesser of amounts due and payable or the amount of
the arrangement fee that would have been recognized if the fee were fixed or
determinable.
Certain of the Company's time-based licenses include the rights to
unspecified additional products. Revenue from contracts with the rights to
unspecified additional software products is recognized ratably over the contract
term. The Company recognizes revenue from time-based licenses that include both
unspecified additional software products and extended payment terms that are not
considered to be fixed or determinable in an amount that is the lesser of
amounts due and payable or the ratable portion of the entire fee.
CONSULTING SERVICES. The Company provides design methodology assistance,
specialized services relating to telecommunication systems design and turnkey
design services. The Company's consulting services generally are not essential
to the functionality of the software. The Company's software products are fully
functional upon delivery and implementation does not require any significant
modification or alteration. The Company's services to its customers often
include assistance with product adoption and integration and specialized design
methodology assistance. Customers typically purchase these professional services
to facilitate the adoption of the Company's technology and dedicate personnel to
participate in the services being performed, but they may also decide to use
their own resources or appoint other professional service organizations to
provide these services. Software products are billed separately and
independently from consulting services, which are generally billed on a
time-and-materials or milestone-achieved basis. The Company generally recognizes
revenue from consulting services as the services are performed.
Exceptions to the general rule above involve arrangements where the Company
has committed to significantly alter the features and functionality of its
software or build complex interfaces necessary for the Company's software to
function in the customer's environment. These types of services are considered
to be essential to the functionality of the software. Accordingly, contract
accounting is applied to both the software and service elements included in
these arrangements.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS
(SFAS 141), and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (SFAS 142). SFAS
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and specifies criteria intangible
assets acquired in a purchase method business combination must meet to be
recognized apart from goodwill. SFAS 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested for impairment at least annually in accordance with the provisions of
SFAS 142.
The Company adopted the provisions of SFAS 141 on July 1, 2001. Under SFAS
141, goodwill and intangible assets with indefinite useful lives acquired in a
purchase business combination completed after June 30, 2001, but before SFAS 142
is adopted, will not be amortized but will continue to be evaluated for
impairment in accordance with SFAS 121. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized and tested for impairment in accordance with current accounting
guidance until the date of adoption of SFAS 142.
Upon adoption of SFAS 142, the Company must evaluate its existing intangible
assets and goodwill acquired in purchase business combinations prior to July 1,
2001, and make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, the Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments. The Company will also be required to test goodwill for
impairment in accordance with the provisions of SFAS 142 within the six-month
period following adoption. Any impairment loss will be measured as of the date
of adoption and recognized immediately as the cumulative effect of a change in
accounting principle. Any subsequent impairment losses will be included in
operating activities.
The Company expects to adopt SFAS 142 on November 1, 2002. As of July 31,
2002, unamortized goodwill of $23.1 million will continue to be amortized until
the date of adoption of SFAS 142, in accordance with the Statements.
8
Amortization of goodwill and other intangible assets for the nine-month period
ended July 31, 2002 is $12.1 million. Goodwill totaling $344.9 relates to
acquisitions subsequent to July 1, 2001 and is therefore not amortized in
accordance with SFAS 142. The Company does not have any intangible assets with
an indefinite useful life. The Company is currently evaluating the impact of the
adoption of this statement on its financial position and results of operations.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS (SFAS 143). SFAS 143
requires that asset retirement obligations that are identifiable upon
acquisition, construction or development and during the operating life of a
long-lived asset be recorded as a liability using the present value of the
estimated cash flows. A corresponding amount would be capitalized as part of the
asset's carrying amount and amortized to expense over the asset's useful life.
The Company is required to adopt the provisions of SFAS 143 effective November
1, 2002. The adoption of SFAS 143 will not have a significant impact on the
Company's financial position and results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS (SFAS
144), which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and
the accounting and reporting provisions of APB Opinion No. 30, REPORTING THE
RESULTS OF OPERATIONS FOR A DISPOSAL OF A SEGMENT OF A BUSINESS. The Company is
required to adopt the provisions of SFAS 144 no later than November 1, 2002. The
Company does not expect that the adoption of SFAS 144 will have a significant
impact on its financial position and results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS (SFAS 145). SFAS 145 eliminates the
requirement that gains and losses from the extinguishments of debt be aggregated
and, if material, classified as an extraordinary item, net of the related income
tax effect. However, an entity would not be prohibited from classifying such
gains and losses as extraordinary items so long as they are both unusual in
nature and infrequent in occurrence. The Company is required to adopt the
provisions of SFAS 145 effective November 1, 2002. SFAS 145 also amends SFAS 13,
ACCOUNTING FOR LEASES and certain other authoritative pronouncements to make
technical corrections or clarifications. SFAS 145 is effective related to the
amendment of SFAS 13 for all transactions occurring after May 15, 2002. The
Company does not expect that the adoption of SFAS 145 will have a significant
impact on its financial position and results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES. SFAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING) and requires liabilities associated with exit and disposal
activities to be expensed as incurred. SFAS 146 will be effective for exit or
disposal activities of the Company that are initiated after December 31, 2002.
The Company is evaluating the effect of adopting SFAS 146 on its financial
position and results of operations.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to current year
presentation.
3. ACQUISITION OF AVANT! CORPORATION
On June 6, 2002 (the "closing date"), the Company completed the merger with
Avant! Corporation (Avant!).
REASONS FOR THE ACQUISITION. The Company's Board of Directors unanimously
approved the Company's merger with Avant! at its December 1, 2001 meeting. In
approving the merger agreement, the Board of Directors consulted with legal and
financial advisors as well as with management and considered a number of
factors. Management is willing to pay a premium over the fair value of the
tangible and identifiable intangible assets as the merger is expected to enable
Synopsys to offer its customers a complete end-to-end solution for IC design
that combines Synopsys' logic synthesis and design verification tools with
Avant!'s advanced place and route, physical verification and design integrity
products, thus increasing customers' design efficiencies. By increasing customer
9
design efficiencies, Synopsys expects to be able to better compete for customers
designing the next generation of semiconductors. Further, by gaining access to
Avant!'s physical design and verification products, as well as its broad
customer base and relationships, Synopsys will gain new opportunities to market
its existing products. The foregoing discussion of the information and factors
considered by the Company's Board of Directors is not intended to be exhaustive
but includes the material factors considered by the Company's Board.
PURCHASE PRICE. Holders of Avant! common stock received 0.371 of a share of
Synopsys common stock (including the associated preferred stock rights) in
exchange for each share of Avant! common stock owned as of the closing date,
aggregating 14.5 million shares of Synopsys common stock. The fair value of the
Synopsys shares issued was based on a per share value of $54.74, which is equal
to Synopsys' average last sale price per share as reported on the Nasdaq
National Market for the trading-day period two days before and after December 3,
2001, the date of the merger agreement.
The total purchase consideration consists of the following:
(IN THOUSANDS)
Fair value of Synopsys common stock issued $ 795,388
Estimated acquisition related costs 37,342
Estimated facilities closure costs 62,638
Estimated employee severance costs 50,367
Estimated fair value of options to purchase Synopsys common stock to
be issued, less $8.1 million representing the portion of the
intrinsic value of Avant!'s unvested options applicable to the
remaining vesting period 63,033
-----------------
$ 1,008,768
=================
The estimated acquisition-related costs of $37.3 million consist primarily
of banking, legal and accounting fees, printing costs, and other directly
related charges including contract termination costs of $6.7 million. The
Company is currently reviewing all outstanding Avant! contracts to determine the
additional cost, if any, to exit existing contracts which may result in
additional accruals for contract termination costs in accordance with Emerging
Issues Task Force (EITF) Issue No. 95-3. Any such accruals would increase the
purchase consideration and the allocation of the purchase consideration to
goodwill.
Estimated facilities closure costs includes $54.2 million related to
Avant!'s corporate headquarters. The lessor has brought a claim against the
Company for the future amounts payable under the lease agreements. The amount
accrued at the closing date is equal to the future amounts payable under the
related lease agreements, without taking into consideration in the accrual any
defenses we may have to the claim. Resolution of this contingency at an amount
different from that accrued will result in an increase or decrease in the
purchase consideration and the amount allocated to goodwill. The remaining
estimated facilities closure costs totaling $8.4 million represents the present
value of the future obligations under certain of Avant!'s lease agreements which
the Company has or intends to terminate under an approved facilities exit plan
plus additional costs expected to be incurred directly related to vacating such
facilities.
Estimated employee severance costs include (i) $39.6 million in cash paid to
Avant!'s Chairman of the Board, consisting of severance plus a cash payment
equal to the intrinsic value of his in-the-money stock options at the closing
date, (ii) $4.5 million in cash severance payments paid to redundant employees
(primarily sales and corporate infrastructure personnel) terminated on or
subsequent to the consummation of the merger under an approved plan of
termination and (iii) $6.3 million in termination payments to certain executives
in accordance with their respective pre-merger employment agreements. The total
number of Avant! employees expected to be terminated as a result of the merger
is approximately 250.
10
As of July 31, 2002, $73.3 million of costs described in the three preceding
paragraphs have been paid and $77.1 million of these costs have not yet been
paid. The following table presents the components of acquisition-related costs
recorded, along with amounts paid through the third quarter of 2002.
Payments
Total Cost through Balance at
(IN THOUSANDS) July 31, 2002 July 31, 2002
------------ ---------------- ----------------
Estimated acquisition related costs $ 37,342 $23,967 $13,375
Estimated facilities closure costs 62,638 262 62,376
Estimated employee severance costs 50,367 49,031 1,336
------------ ---------------- ----------------
Total $150,347 $73,260 $77,087
============ ================ ================
The total purchase consideration has been allocated on a preliminary basis
to the assets and liabilities acquired, including identifiable intangible
assets, based on their respective fair value at the acquisition date and
resulted in excess purchase consideration over the net tangible and identifiable
intangible assets acquired of $344.9 million. The following unaudited condensed
balance sheet data presents the preliminary fair value of the assets and
liabilities acquired and recorded at June 6, 2002.
(IN THOUSANDS)
Assets acquired
Cash, cash equivalents and short-term investments $ 241,313
Accounts receivable 67,154
Prepaid expenses and other current assets 19,483
Assets held for sale 33,220
Intangible assets 365,000
Goodwill 344,949
Other assets 3,876
----------------
Total assets acquired $ 1,074,995
================
Liabilities acquired
Accounts payable and accrued liabilities $ 172,528
Deferred revenue 30,080
Income taxes payable 94,576
Other liabilities 4,651
----------------
Total liabilities acquired $ 301,835
================
Other current assets acquired includes an investment in a venture-capital
fund valued at $12.8 million. Management intends to dispose of this investment;
however, the Company has been unable to obtain certain financial records and
information required to effectively market the investment. The fair value of the
asset recorded does not include any adjustment of this investment due to this
contingency. Any adjustment to the fair-value of this investment which is
ultimately made will increase or decrease the purchase consideration and the
allocation of the purchase consideration to goodwill.
11
UNAUDITED PRO FORMA RESULTS OF OPERATIONS. The following table presents pro
forma results of operations and gives effect to the proposed merger as if the
merger had been consummated on November 1, 2000. The unaudited pro forma results
of operations are not necessarily indicative of the results of operations had
the acquisition actually occurred at the beginning of fiscal 2001, nor is it
necessarily indicative of future operating results:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
-------------- -------------- ------------ ------------
Revenues $ 278,217 $ 276,922 $ 861,822 $ 789,308
Net income (loss) 16,099 18,434 71,697 (188,593)
Basic earnings (loss) per share $ 0.23 $ 0.25 $ 1.12 $ (2.50)
Weighted average common shares outstanding 71,157 74,578 64,157 75,580
Diluted earnings (loss) per share $ 0.21 $ 0.23 $ 1.04 $ (2.50)
Weighted average common shares and dilutive stock
options outstanding 71,157 80,351 64,157 75,580
The unaudited pro forma results of operations for each of the periods
presented exclude non-recurring merger costs of $95,000 and $82,500 for the
contingently refundable insurance policy and IPRD recorded by Synopsys in the
third quarter of 2002 and included in the historical condensed consolidated
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 consistent with the guidance
with SFAS 142. The goodwill associated with the Avant! acquisition is not
deductible for tax purposes. In addition, a portion of the purchase price was
allocated to the following identifiable intangible assets:
Intangible Asset (IN THOUSANDS) Estimated Useful Life
- ------------------------------------- ----------------- ------------------------
Core/developed technology $184,000 3 years
Contract rights intangible 51,700 3 years
Customer installed base/relationship 102,500 6 years
Trademarks and tradenames 17,700 3 years
Covenants not to compete 9,100 The life of the related
agreement (2 to 4 years)
----------------
Total $365,000
================
CONTRACT RIGHTS INTANGIBLE. Avant! had executed signed license agreements,
had delivered the initial configuration of licensed technologies under ratable
license arrangements and had executed signed contracts to provide PCS over a one
to three year period, for which Avant! did not consider the fees to be fixed and
determinable at the outset of the arrangement. There were no receivables or
deferred revenues recorded on Avant!'s historical financial statements at the
closing date as the related payments were not yet due under extended payment
terms and deliveries are scheduled to occur over the term of the arrangements.
These ratable licenses and PCS arrangements require future performance by both
parties and, as such, represent executory contracts. The contract rights
intangible asset associated with these arrangements is amortized to cost of
revenues over the related contract lives.
The amortization of intangible assets, with the exception of the contract
rights intangible and the core/developed technology, is included in operating
expenses in the statement of operations for the three- and nine-month periods
ended July 31, 2002. Amortization of the core/developed technology and contract
rights intangible is included in cost of revenue.
ASSET HELD FOR SALE. In January 2001, Synopsys sold the assets of its
silicon libraries business to Artisan Components, Inc. ("Artisan") and entered
into an agreement not to engage, directly or indirectly, in the physical
libraries business before January 3, 2003. Synopsys also agreed that if it
acquired a physical libraries business as part of a larger acquisition, then
Artisan would have certain preferential rights to negotiate and bid for such
business. Prior to the merger, Avant! engaged in the physical libraries
business. As a result of the merger, Synopsys acquired Avant!'s physical
libraries business, and Synopsys is obligated to offer and sell such business to
Artisan under the terms of the January 2001 agreement. The value allocated to
the acquired libraries business was recorded as net assets held for sale and is
based on the estimated future net cash flows from the libraries business in
accordance with EITF 87-11, ALLOCATION OF PURCHASE PRICE TO ASSETS TO BE SOLD.
The carrying value of the libraries business as of July 31, 2002 is
approximately $33.1 million and losses for the period from June 6, 2002 through
July 31, 2002 that have been excluded from the consolidated income statement
were approximately $0.5 million.
12
CONTINGENTLY REFUNDABLE INSURANCE POLICY. Avant!, which upon completion of
the Synopsys-Avant! merger became a wholly-owned subsidiary of Synopsys is a
party to a number of material civil litigation matters, including civil
litigation (the Avant!/Cadence litigation) brought by Cadence Design Systems,
Inc. (Cadence) as discussed in Footnote 12. Synopsys obtained an insurance
policy from a subsidiary of American International Group, Inc., a AAA-rated
insurance company, whereby insurance was obtained for certain compensatory,
exemplary and punitive damages, penalties and fines and attorneys' fees arising
out of the Avant!/Cadence litigation. The policy does not provide coverage for
litigation other than the Avant!/Cadence litigation.
The Company paid a total premium of $335 million for the policy, of which
$240 million is contingently refundable. Under the policy the insurer is
obligated to pay covered loss up to a limit of liability equaling (a) $500
million plus (b) interest accruing at the fixed rate of 2%, compounded
semi-annually, on $250 million (the "interest component"), as reduced by
previous covered losses. The policy will expire following a final judgment or
settlement of the Avant!/Cadence litigation or any earlier date upon Synopsys'
election. Upon such expiration, Synopsys will be entitled to a payment equal to
$240 million plus the interest component less any covered loss (which, for this
purpose, shall include legal fees only to the extent that the aggregate amount
of such fees exceeds $10 million).
The contingently refundable portion of the insurance premium ($240 million)
is included in the July 31, 2002 balance sheet as a long-term restricted asset.
Interest earned on $250 million will be included in other income, net in the
post-merger statement of operations. The balance of the premium paid to the
insurer ($95 million) is included in integration expense for the three- and
nine-month periods ended July 31, 2002.
At the closing date, the Avant!/Cadence litigation was accounted for as a
pre-merger contingency because a litigation judgment or settlement amount, if
any, is not probable or estimable. If a litigation loss becomes probable and
estimable, such loss will be included in net income.
VALUATION OF IPRD. The amounts allocated to purchased research and
development, totaling $82.5 million, were determined through established
valuation techniques in the high-technology industry and were expensed upon
acquisition because technological feasibility had not been established and no
future alternative uses existed. Research and development costs to bring the
products to technological feasibility are expected to total approximately $17.5
million.
4. STOCK REPURCHASE PROGRAM
In July 2001, the Company's Board of Directors authorized a stock repurchase
program under which Synopsys common stock with a market value up to $500 million
may be acquired in the open market. This stock repurchase program replaced all
prior repurchase programs authorized by the Board. Common shares repurchased are
intended to be used for ongoing stock issuances under the Company's employee
stock plans, for acquisitions and for other corporate purposes. The July 2001
stock repurchase program expires on October 31, 2002. During the three-month and
nine-month periods ended July 31, 2001, the Company purchased 2.4 million and
6.6 million shares, respectively, of Synopsys common stock in the open market
under a prior stock repurchase program, at average prices of $53 per share and
$50 per share, respectively. The Company repurchased 0.8 million shares during
the three-month and nine-month periods ended July 31, 2002 at an average price
of $50 per share. At July 31, 2002, approximately $440.1 million remained
available for repurchases under the July 2001 program.
5. COMPREHENSIVE (LOSS) INCOME
The following table sets forth the components of comprehensive (loss)
income, net of income tax expense:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
---------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ----------------- ----------------- ----------------
(IN THOUSANDS)
Net (loss) income $(137,589) $ 14,450 $ (102,157) $ 36,404
Foreign currency translation adjustment (4,672) (936) (4,218) (3,763)
Unrealized (loss) gain on investments (10,720) 1,803 (4,016) (1,863)
Reclassification adjustment for realized
gains on investments -- (7,967) (5,842) (25,566)
---------------- ----------------- ----------------- ----------------
Total comprehensive (loss) income $(152,981) $ 7,350 $ (116,233) $ 5,212
================ ================= ================= ================
13
6. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted-average number of common shares and dilutive
employee stock options outstanding during the period. The weighted-average
dilutive stock options outstanding is computed using the treasury stock method.
For the three- and nine-month periods ended July 31, 2002, due to the net loss
incurred for such periods, the effect of employee stock options is
anti-dilutive.
The following is a reconciliation of the weighted-average common shares used
to calculate basic net earnings per share to the weighted-average common shares
used to calculate diluted net income per share:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- ---------------- --------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NUMERATOR
Net (loss) income $ (137,589) $ 14,450 $ (102,157) $ 36,404
=============== ================ =============== ================
DENOMINATOR:
Weighted-average common shares
outstanding 71,157 60,048 64,157 61,050
Effect of dilutive employee stock options - 4,839 - 4,312
--------------- ---------------- --------------- ----------------
Diluted common shares 71,157 64,887 64,157 65,362
=============== ================ =============== ================
Basic (loss) earnings per share $ (1.93) $ 0.24 $ (1.59) $ 0.60
=============== ================ =============== ================
Diluted (loss) earnings per share $ (1.93) $ 0.22 $ (1.59) $ 0.56
=============== ================ =============== ================
The effect of dilutive employee stock options excludes approximately
7,445,643 and 3,577,000 stock options for the three-month periods ended July 31,
2002 and 2001, respectively, and 5,339,772 and 3,513,000 for the nine-month
periods ended July 31, 2002 and 2001, respectively, which were anti-dilutive for
earnings per share calculations.
7. SEGMENT DISCLOSURE
Statement of Financial Accounting Standards No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION (SFAS 131), requires
disclosures of certain information regarding operating segments, products and
services, geographic areas of operation and major customers. The method for
determining what information to report under SFAS 131 is based upon the
"management approach," or the way that management organizes the operating
segments within a Company for which separate financial information is available
that is evaluated regularly by the Chief Operating Decision Maker (CODM) in
deciding how to allocate resources and in assessing performance. Synopsys' CODM
is the Chief Executive Officer and Chief Operating Officer.
The Company provides comprehensive design technology products and consulting
services in the EDA software industry. The CODM evaluates the performance of the
Company based on profit or loss from operations before income taxes not
including integration costs, in-process research and development and
amortization of intangible assets and deferred stock compensation. For the
purpose of making operating decisions, the CODM primarily considers financial
information presented on a consolidated basis accompanied by disaggregated
information about revenues by geographic region. There are no differences
between the accounting policies used to measure profit and loss for the Company
segment and those used on a consolidated basis. Revenue is defined as revenues
from external customers.
14
The disaggregated financial information reviewed by the CODM is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ---------------------------------
2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Revenue:
Product $ 60,096 $ 44,858 $ 151,944 $ 117,152
Service 73,924 81,430 208,782 259,900
Ratable license 102,075 49,822 236,552 119,736
---------------- ---------------- ---------------- ----------------
Total revenue $ 236,095 $ 176,110 $ 597,278 $ 496,788
================ ================ ================ ================
Gross margin before amortization of intangible
assets and deferred stock compensation $ 201,775 $ 143,390 $ 493,376 $ 401,056
Operating income (loss) before integration
costs, in-process research and development
and amortization of intangible assets and
deferred stock compensation $ 49,164 $ 5,914 $ 86,165 $ (851)
There were no integration, in-process research and development or
amortization of deferred stock compensation costs during the three- and
nine-month periods ended July 31, 2001.
A reconciliation of the Company's segment gross margin to the Company's
gross margin is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ---------------------------------
2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Gross margin before amortization of intangible
assets and deferred stock compensation $ 201,775 $ 143,390 $ 493,376 $ 401,056
Amortization of intangible assets and deferred
stock compensation (13,366) -- (13,366) --
---------------- ---------------- ---------------- ----------------
Gross margin $ 188,409 $ 143,390 $ 480,010 $ 401,056
================ ================ ================ ================
Reconciliation of the Company's segment profit and loss to the Company's
operating (loss) income before (benefit) provision for income taxes is as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
---------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ----------------- ---------------- -----------------
(IN THOUSANDS)
Operating income (loss) before integration
costs, in-process research and development
and amortization of intangible assets and
deferred stock compensation $ 49,164 $ 5,914 $ 86,165 $ (851)
Integration costs (117,266) -- (117,266) --
In-process research and development (82,500) -- (82,500) --
Amortization of intangible assets and deferred
stock compensation (22,186) (4,163) (30,586) (12,514)
---------------- ----------------- ---------------- -----------------
Operating (loss) income $ (172,788) $ 1,751 $ (144,187) $ (13,365)
================ ================= ================ =================
15
Revenue and long-lived assets related to operations in the United States and
other geographic areas are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ---------------- ----------------- ----------------
(IN THOUSANDS)
Revenue:
United States $ 154,501 $ 110,770 $ 390,529 $ 306,650
Europe 34,992 33,460 98,584 91,214
Japan 25,758 18,405 59,783 53,060
Other 20,844 13,475 48,382 45,864
---------------- ---------------- ----------------- ----------------
Consolidated $ 236,095 $ 176,110 $ 597,278 $ 496,788
================ ================ ================= ================
JULY 31, OCTOBER 31,
2002 2001
---------------- ---------------
(IN THOUSANDS)
Long-lived assets:
United States $ 160,270 $ 176,330
Other 25,602 15,974
---------------- ---------------
Consolidated $ 185,872 $ 192,304
================ ===============
Geographic revenue data for multi-region, multi-product transactions reflect
internal allocations and is therefore subject to certain assumptions and to the
Company's methodology. Revenue is not reallocated among geographic regions to
reflect any re-mixing of licenses between different regions following the
initial product shipment. One customer accounted for approximately 15% and 10%
of the Company's consolidated revenue during the three- and nine-months ended
July 31, 2002, respectively. No one customer accounted for more than ten percent
of the Company's consolidated revenue during the three- and nine-months ended
July 31, 2001.
The Company segregates revenue into five categories for purposes of internal
management reporting: Design Implementation, Verification and Test, Design
Analysis, Intellectual Property (IP) and Professional Services. The following
table summarizes the revenue attributable to each of the various categories.
Revenue attributable to products acquired from Avant! that was recognized by
Avant! prior to June 6, 2002 is not reflected in the following tables. Revenue
attributable to such products from June 6, 2002 through July 31, 2002 is
included in the three- and nine- months ended July 31, 2002. As a result of the
Avant! merger, the Company has redefined its product groups. Prior period
amounts have been reclassified to conform to the new presentation.
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- ---------------- ---------------- ---------------
(IN THOUSANDS)
Revenue
Design Implementation $ 105,041 $ 68,726 $ 253,946 $ 192,817
Verification and Test 62,216 59,037 191,471 161,301
Design Analysis 40,616 11,300 61,745 30,216
IP 13,359 18,101 45,150 47,402
Professional Services 14,863 18,946 44,966 65,052
--------------- ---------------- ---------------- ---------------
Consolidated $ 236,095 $ 176,110 $ 597,278 $ 496,788
=============== ================ ================ ===============
8. DERIVATIVE FINANCIAL INSTRUMENTS
Available-for-sale equity investments accounted for under Statement of
Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES (SFAS 115), are subject to market price risk. From
time to time, the Company enters into and designates forward contracts to hedge
variable cash flows from anticipated sales of these investments. The Company
recorded a net realized gain on the sale of the available-for-sale investments
including the settlement of forward contracts of $10.3 million and $13.1 million
(net of premium amortization), respectively, during the three-month periods
ended July 31, 2002 and 2001 and $22.8 million and $41.9 million (net of premium
16
amortization), respectively, during the nine-month periods ended July 31, 2002
and 2001. As of July 31, 2002, the Company has recorded $7.6 million in
long-term investments due to locked-in unrealized gains on the
available-for-sale investments. As of July 31, 2002, the maximum length of time
over which the Company is hedging its exposure to the variability in future cash
flows associated with the forward sale contracts is 6 months.
9. TERMINATION OF AGREEMENT TO ACQUIRE IKOS SYSTEMS, INC.
On July 2, 2001, the Company entered into an Agreement and Plan of Merger
with IKOS Systems, Inc. (IKOS). The Agreement provided for the acquisition of
all outstanding shares of IKOS common stock by Synopsys.
On December 7, 2001, Mentor Graphics Corporation (Mentor) commenced a cash
tender offer to acquire all of the outstanding shares of IKOS common stock at
$11.00 per share, subject to certain conditions. On March 12, 2002, Synopsys and
IKOS executed a termination agreement by which the parties terminated the
Synopsys-IKOS merger agreement and pursuant to which IKOS paid Synopsys the $5.5
million termination fee required under the Synopsys-IKOS merger agreement. This
termination fee and $2.4 million of expenses incurred in conjunction with the
acquisition are included in other income, net on the unaudited condensed
consolidated statement of income for the nine-month period ended July 31, 2002.
Synopsys subsequently executed a revised termination agreement with Mentor and
IKOS in order to add Mentor as a party thereto.
10. WORKFORCE REDUCTION
In March 2002, the Company implemented a workforce reduction. The purpose
was to reduce expenses by decreasing the number of employees in all departments,
both domestically and internationally. As a result, the Company's workforce was
decreased by approximately 175 employees and a charge of approximately $3.9
million is included in operating expenses during the nine-month period ended
July 31, 2002. This charge consists of severance and other special termination
benefits.
11. DEFERRED STOCK COMPENSATION
In connection with the Avant! acquisition, the Company assumed unvested
stock options held by former Avant! employees. The Company has recorded deferred
stock compensation totaling $8.1 million based on the intrinsic value of the
assumed unvested stock options. The deferred stock compensation is amortized
over the options' remaining vesting period of one to three years. During the
three- and nine-months ended, July 31, 2002, the Company recorded amortization
of deferred stock compensation in each of the following expense classifications
on the statement of operations:
(IN THOUSANDS)
Cost of revenues $ 58
Research and development 309
Sales and marketing 105
General and administrative 38
--------
Total $510
========
12. CADENCE LITIGATION
Avant! and its subsidiaries are engaged in the Avant!/Cadence litigation, a
material civil litigation matter. The Avant!/Cadence litigation generally arises
out of the same set of facts that were the subject of a criminal action brought
against Avant! and several individuals by the District Attorney of Santa Clara
County, California (the "Santa Clara criminal action"). Avant!, Gerald C. Hsu,
Chairman of Avant! and five former Avant! employees pled no contest to certain
of the charges in the Santa Clara criminal action. As part of that plea, Avant!
paid approximately $35.3 million in fines and a hearing was held on the amount
of restitution owed to Cadence. During the hearing, Cadence claimed losses of
$683.3 million. Ultimately, the court in the Santa Clara criminal action
required Avant! to pay Cadence restitution in the amount of $195.4 million. That
amount has been fully paid.
Cadence seeks compensatory damages and treble or other exemplary damages
from Avant! in the Avant!/Cadence litigation under theories of copyright
infringement, misappropriation of trade secrets, inducing breach of contract and
false advertising. Synopsys believes Avant! has defenses to all of Cadence's
claims in the Avant!/Cadence litigation. Cadence has not fully quantified the
amount of damages it seeks in the Avant!/Cadence litigation. Should Cadence
17
ultimately succeed in the prosecution of its claims, however, Avant! could be
required to pay substantial monetary damages to Cadence. Some or all of these
damages may be offset by the $195.4 million restitution paid to Cadence in the
Santa Clara criminal action. Approximately $500 million in additional damages
would be covered by the insurance policy Synopsys has obtained with respect to
the Avant!/Cadence litigation.
Injunctions entered in 1997 and 1998 enjoined Avant! from marketing its
early place and route products, ArcCell and Aquarius, based on a judicial
determination that they incorporated portions of Cadence's Design Framework II
source code (DFII). The injunctions also prohibit Avant! from possessing, using,
selling or licensing any product or work copied or derived from DFII and
directly or indirectly marketing, selling leasing, licensing, copying or
transferring any of the ArcCell or Aquarius products. Avant! ceased marketing,
selling, leasing, licensing or supporting all of the ArcCell or Aquarius
products in 1996 and 1999, respectively. The DFII code is not incorporated in
any current Avant! product. Although Cadence has not made a claim in the
Avant!/Cadence litigation against any current Avant! product, including its
Apollo and Astro place and route products, and has not introduced any evidence
that any such product infringes Cadence's intellectual property rights, Cadence
has publicly implied that it intends to assert such claims. Synopsys believes it
would have defenses to any such claims. Nonetheless, should Cadence be
successful at proving that any past or then-current Avant! product incorporated
intellectual property misappropriated from Cadence, Synopsys could be
permanently enjoined from further use of such intellectual property, which might
require modification to existing products and/or suspension of the sale of such
products until such Cadence intellectual property was removed.
13. SUBSEQUENT EVENT - ACQUISITION OF INSILICON CORPORATION
On July 23, 2002, Synopsys entered into an Agreement and Plan of Merger
with inSilicon Corporation (inSilicon) under which Synopsys commenced a cash
tender offer to acquire all of the outstanding shares of inSilicon common stock
at $4.05 per share or approximately $64.9 million, subject to certain
conditions. Following the consummation of the tender offer, inSilicon will merge
with and into a wholly owned subsidiary of Synopsys. Synopsys will account for
the merger under the purchase method of accounting. The merger is subject to
certain conditions, including approval of the merger and the Agreement and Plan
of Merger by the inSilicon stockholders, compliance with regulatory requirements
and customary closing conditions.
14. SUBSEQUENT EVENT - ACQUISITION OF CO-DESIGN
On September 6, 2002, Synopsys acquired all of the outstanding shares of
capital stock of Co-Design Automation, Inc. (Co-Design) for consideration
consisting of cash and notes of $29.7 million and $4.8 million, respectively,
and assumed options with an aggregate value of approximately $1.3 million. The
Company will account for the merger under the purchase method of accounting.
Synopsys purchased Co-Design for a number of reasons, including (i) the
combination of Co-Design's technology with Synopsys' verification tools is
expected to speed the delivery of next-generation hardware description language
solutions; (ii) the acquisition will help promote the use of the Superlog
language, which Synopsys believes will be important in developing next
generation verification tools and increasing designer productivity; and (iii)
the acquisition gives Synopsys access to Co-Design's industry experts. As of the
date of filing this Form 10-Q, the valuation of Co-Design's assets and
liabilities, including identifiable intangible assets, as of the closing date
has not been completed.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. Such
forward-looking statements include the statements concerning the effect of
Technology Subscription Licenses on our revenue, expectations for revenue and
costs of revenue, expectations about gains from the sale of investments, effects
of foreign currency hedging, adequacy of our cash as well as statements
including the words "projects," "expects," "believes," "anticipates", "will" or
similar expressions. Actual results could differ materially from those
anticipated in such forward-looking statements as a result of certain factors,
including those set forth under "Factors That May Affect Future Results."
18
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to revenue recognition, bad debts, investments, intangible assets
and income taxes. Our estimates are based on historical experience and on
various other assumptions we believe are reasonable under the circumstances.
Actual results may differ from these estimates.
The accounting policies described below are the ones that most frequently
require us to make estimates and judgments, and are therefore critical to
understanding our results of operations.
REVENUE RECOGNITION AND COST OF REVENUE. Our revenue recognition policy is
detailed in Note 2 of the Notes to Unaudited Condensed Consolidated Financial
Statements. Management has made significant judgments related to revenue
recognition; specifically, evaluating whether our fee relating to an arrangement
is fixed or determinable and assessing whether collectibility is probable. These
judgments are discussed below.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. In order to recognize revenue, we
must make a judgment as to whether the arrangement fee is fixed or determinable.
Except in cases where we grant extended payment terms to a specific customer, we
have determined that our fees are fixed or determinable at the inception of our
arrangements based on the following:
o The fee our customers pay for our products is negotiated at the outset
of an arrangement and is generally based on the specific volume of
products to be delivered.
o Our license fees are not a function of variable-pricing mechanisms
such as the number of units distributed or copied by the customer or
the expected number of users of the product delivered.
Our customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. These customary payment terms
are supported by historical practice and concessions have not been granted to
customers under this policy. Arrangements with payment terms extending beyond
the customary payment terms are considered not to be fixed or determinable.
Revenue from such arrangements is recognized at the lesser of the aggregate of
amounts due and payable or the amount of the arrangement fee that would have
been recognized if the fees had been fixed or determinable.
COLLECTIBILITY IS PROBABLE. In order to recognize revenue, we must make a
judgment of the collectibility of the arrangement fee. Our judgment of the
collectibility is applied on a customer-by-customer basis pursuant to our credit
review policy. We typically sell to customers for which there is a history of
successful collection. New customers are subjected to a credit review process,
which evaluates the customers' financial positions and ability to pay. New
customers are typically assigned a credit limit based on a formulated review of
their financial position. Such credit limits are only increased after a
successful collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not probable
based upon our credit review process, revenue is recognized on a cash-collected
basis.
VALUATION OF STRATEGIC INVESTMENTS. As of July 31, 2002, the adjusted cost
of our strategic investments totaled $41.4 million. We review our investments in
non-public companies and estimate the amount of any impairment incurred during
the current period based on specific analysis of each investment, considering
the activities of and events occurring at each of the underlying portfolio
companies during the quarter. Our portfolio companies operate in industries that
are rapidly evolving and extremely competitive. For equity investments in
non-public companies where there is not a market in which their value is readily
determinable, we assess each investment for indicators of impairment at each
quarter end based primarily on achievement of business plan objectives and
current market conditions, among other factors, and information available to us
at the time of this quarterly assessment. The primary business plan objectives
we consider include, among others, those related to financial performance such
as achievement of planned financial results or completion of capital raising
activities, and those that are not primarily financial in nature such as the
launching of technology or the hiring of key employees. If it is determined that
an impairment has occurred with respect to an investment in a portfolio company,
in the absence of quantitative valuation metrics, management estimates the
impairment and/or the net realizable value of the portfolio investment based on
19
public- and private-company market comparable information and valuations
completed for companies similar to our portfolio companies. Future adverse
changes in market conditions, poor operating results of underlying investments
and other information obtained after our quarterly assessment could result in
losses or an inability to recover the current carrying value of the investments
thereby possibly requiring an impairment charge in the future. Based on these
measurements, an impairment loss of $4.0 million and $7.5 million was recorded
during the three- and nine-month periods ended July 31, 2002.
VALUATION OF INTANGIBLE ASSETS. Intangible assets, net of accumulated
amortization, totaled $351.2 million as of July 31, 2002. We periodically
evaluate our intangible assets for indications of impairment whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Intangible assets include goodwill, purchased technology and
capitalized software. Factors we consider important which could trigger an
impairment review include significant under-performance relative to expected
historical or projected future operating results, significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business or significant negative industry or economic trends. If this evaluation
indicates that the value of the intangible asset may be impaired, an evaluation
of the recoverability of the net carrying value of the asset over its remaining
useful life is made. If this evaluation indicates that the intangible asset is
not recoverable, based on the estimated undiscounted future cash flows of the
entity or technology acquired over the remaining amortization period, the net
carrying value of the related intangible asset will be reduced to fair value and
the remaining amortization period may be adjusted. Any such impairment charge
could be significant and could have a material adverse effect on our reported
financial statements if and when an impairment charge is recorded. If an
impairment charge is recognized, the amortization related to goodwill and other
intangible assets would decrease during the remainder of the fiscal year. No
impairment losses were recorded during the current quarter based on these
measurements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. As of July 31, 2002, the allowance for
doubtful accounts totaled $23.0 million. Management estimates the collectibility
of our accounts receivable on an account-by-account basis. We record an increase
in the allowance for doubtful accounts when the prospect of collecting a
specific account receivable becomes doubtful. In addition, we provide for a
general reserve on all accounts receivable, using a specified percentage of the
outstanding balance in each aged group. Management specifically analyzes
accounts receivable and historical bad debt experience, customer
creditworthiness, current economic trends, international exposures (such as
currency devaluation), and changes in our customer payment terms when evaluating
the adequacy of the allowance for doubtful accounts. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
INCOME TAXES. Our effective tax rate is directly affected by the relative
proportions of domestic and international revenue and income before taxes. We
are also subject to changing tax laws in the multiple jurisdictions in which we
operate. As of July 31, 2002, deferred tax assets and liabilities totaled $169.2
million and $23.3 million, respectively. We believe that it is more likely than
not that the results of future operations will generate sufficient taxable
income to utilize these net deferred tax assets. While we have considered future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the need for any valuation allowance, should we determine that we
would not be able to realize all or part of our net deferred tax asset in the
future, an adjustment to the deferred tax asset would be charged to income in
the period such determination was made.
RESULTS OF OPERATIONS
On June 6, 2002 (the "closing date"), the Company completed the merger with
Avant! Corporation (Avant!), a company which develops, markets, licenses and
supports electronic design automation software products that assist design
engineers in the physical layout, design, verification, simulation, timing and
analysis of advanced integrated circuits. Under the terms of the merger
agreement between the Company and Avant!, Avant! merged with and into a
wholly-owned subsidiary of Synopsys. The merger is accounted for under the
purchase method of accounting. The results of operations of Avant! are included
in the accompanying condensed consolidated financial statements for the period
from the closing date through July 31, 2002.
REVENUE. Revenue consists of fees for perpetual and ratable licenses of our
software products, sales of hardware system products, post-contract customer
support (PCS), customer training and consulting. We classify revenues as
product, service or ratable license. Product revenue consists primarily of
perpetual license product revenue. Service revenue consists of PCS under
perpetual licenses and fees for consulting services and training. Ratable
20
license revenue consists of all revenue from our technology subscription
licenses (TSLs) and from time-based licenses sold prior to the adoption of TSLs
in August 2000 that include extended payment terms or unspecified additional
products.
TSLs are time-limited rights to use our software. Since TSLs include
bundled product and services, both product and service revenue is generally
recognized ratably over the term of the license, or, if later, as payments
become due. The terms of TSLs, and the payments due thereon, may be structured
flexibly to meet the needs of the customer. In certain situations, customers
have limited rights to new technology through reconfiguration clauses under
their agreements.
We introduced TSLs in the fourth quarter of fiscal 2000. The replacement of
the prior form of time-based licenses by TSLs has impacted and will continue to
impact our reported revenue. When a customer buys a TSL, relatively little
revenue is recognized during the quarter the product is initially delivered. The
remaining amount will either be recorded as deferred revenue on our balance
sheet or considered backlog by the Company and not recorded on the balance
sheet. The amount recorded as deferred revenue is equal to the portion of the
license fee that has been invoiced or paid but not recognized. The amount
considered backlog moves out of backlog and is recorded as deferred revenue as
invoiced or as additional payments are made. Deferred revenue is reduced as
revenue is recognized. Under the prior form of time-based licenses, a high
proportion of all license revenue was recognized in the quarter that the product
was delivered, with relatively little recorded as deferred revenue or as
backlog. Therefore, an order for a TSL will result in significantly lower
current-period revenue than an equal-sized order under the prior form of
time-based licenses.
Since our introduction of TSLs, the average TSL duration has been
approximately 3.25 years. This means that, absent the Avant! merger, the
transition of our license base to TSLs would continue to impact our reported
revenue until at least the first quarter of fiscal year 2004. This transition
period will be extended as a result of our merger with Avant!. Avant!'s
historical license order mix had a higher proportion of perpetual licenses and a
lower proportion of ratable licenses than the Synopsys license order mix from
August 2000 to the present (i.e., since our adoption of TSLs), which has been
22% perpetual licenses and 78% ratable licenses. We expect that the future
license order mix of the combined company will approach, over time, the Synopsys
license mix, though it is likely to fluctuate from quarter to quarter.
We set revenue targets for any given quarter based, in part, upon an
assumption that we will achieve a certain license mix of perpetual licenses and
TSLs. The actual mix of licenses sold affects the revenue we recognize in the
period. If we are unable to achieve our target license mix, we may not meet our
revenue targets. Our target license mix for total new software license orders
for the fourth quarter of fiscal year 2002 is 20% to 25% perpetual licenses and
75% to 80% ratable licenses. For fiscal year 2003, our preliminary target
license mix for total new software license orders is 22% to 27% perpetual
licenses and 73% to 78% ratable licenses. These ranges are preliminary and are
subject to revision based on developments in our business. In addition, the
precise mix of orders is subject to substantial fluctuation in any given quarter
or multiple quarter period. In the third quarter of fiscal 2002, the license mix
was approximately 32% perpetual licenses and 68% TSLs, in comparison to 29%
perpetual licenses and 71% TSLs in the third quarter of fiscal 2001.
As expected, total revenue for the third quarter of fiscal 2002 increased
34% to $236.1 million compared to $176.1 million for the third quarter of fiscal
2001. Revenue for the nine months ended July 31, 2002 increased 20% to $597.3
million compared to $496.8 million for the nine months ended July 31, 2001. The
increase in total revenue for the three- and nine months ended July 31, 2002
compared to the same periods in 2001 is due primarily to the Avant! acquisition,
and to the additional quarters that the TSL license model has been used and the
related increase in revenue due to the timing of revenue recognition under this
model.
Product revenue increased 34% to $60.1 million for the third quarter of
fiscal 2002, compared to $44.9 million for the third quarter of fiscal 2001 and
30% to $151.9 million for the nine months ended July 31, 2002 compared to $117.2
million for the same period in fiscal 2001. The increase in product revenue is
directly related to the increase in orders for perpetual licenses during the
periods, since, in most cases, product revenue is recognized in the same quarter
that an order for a perpetual license is received and to the increased volume as
a result of the Avant! merger. During the second quarter of 2002, we began
offering variable maintenance arrangements to certain customers that entered
into perpetual license technology arrangements in excess of $2.0 million. Under
these arrangements, the annual fee for PCS is calculated as a percentage of the
net license fee rather than a fixed percentage of the list price.
Service revenue decreased 9% to $73.9 million for the third quarter of
fiscal 2002, compared to $81.4 million for the third quarters of fiscal 2001,
and decreased 20% to $208.8 million for the nine months ended July 31, 2002
21
compared to $259.9 million for the same period in fiscal 2001. The decreases in
both periods are due in part to economic factors and in part to the impact of
our adoption of TSLs on our overall license mix. Economic conditions have led
our customers to reduce their costs by curtailing their use of outside
consultants and, in some cases, discontinuing maintenance on their perpetual
license. As a result, we received a lower volume of new consulting orders than
expected, and certain projects in the consulting backlog were deferred or
cancelled. Customer expenditures on training have also been reduced, which has
reduced our revenue from training. These conditions are expected to continue at
least until the semiconductor industry recovers. The shift to TSLs has impacted
service revenue in two ways. First, new licenses structured as TSLs include
bundled PCS, which means that revenue attributable to PCS is recognized as
ratable revenue. If such licenses were perpetual licenses or time-based licenses
similar to the type that we used to offer, the PCS revenue relating to such
licenses would be recognized as service revenue. Second, customers with existing
perpetual licenses are entering into new TSLs rather than renewing the PCS on
the existing perpetual licenses. In each case, revenue attributable to PCS that
otherwise would have been reflected in service revenue is now reflected in
ratable license revenue.
REVENUE EXPECTATIONS. For the fourth quarter of fiscal year 2002, we expect
revenue to consist of 25% to 30% product revenue, 45% to 50% TSLs and 25% to 30%
services revenue. For the full fiscal year 2003, we expect revenue to consist of
15% to 20% product revenue, 50% to 55% TSLs and 25% to 30%services revenue.
INTERNATIONAL REVENUE. The following table summarizes the performance of
the various geographic regions as a percent of total Company revenue:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------- ------------- ------------
North America 65% 63% 65% 62%
Europe 15% 19% 17% 18%
Japan 11% 10% 10% 11%
Asia Pacific and Other 9% 8% 8% 9%
------------ ------------- ------------- ------------
Total 100% 100% 100% 100%
============ ============= ============= ============
International revenue as a percentage of total revenue for the quarter ended
July 31, 2002 decreased to 35% from 37% for the quarter ended July 31, 2001 and
to 35% from 38% for the nine-month periods ended July 31, 2002 and 2001,
respectively. In any given period, the geographic mix of revenue is influenced
by the particular contracts signed during the quarter and in prior quarters.
International sales are vulnerable to regional or worldwide economic or
political conditions. In particular, a number of our largest European customers
are in the telecommunications equipment business, which has weakened
considerably, resulting in a quarterly decline in revenues from Europe as a
percentage of total Company revenue during fiscal 2002. The majority of our
international sales are denominated in the U.S. dollar. There were no foreign
exchange gains or losses that were material to our financial results during the
three- and nine-month periods ended July 31, 2002 and 2001.
REVENUE - PRODUCT GROUPS. For management reporting purposes, our products
have been organized into four distinct product groups -- Design Implementation,
Verification and Test, Design Analysis, Intellectual Property (IP) -- and a
services group -- Professional Services. The following table summarizes the
revenue attributable to the various groups as a percentage of total Company
revenue for the last eight quarters. Revenue attributable to products acquired
from Avant! that was recognized by Avant! prior to June 4, 2002 is not reflected
in the following tables. Revenue attributable to such products from June 6, 2002
through July 31, 2002 is included in the third quarter fiscal 2002 revenue. As a
result of the Avant! merger, we have redefined our product groups. Prior period
amounts have been reclassified to conform to the new presentation.
Q3-2002 Q2-2002 Q1-2002 Q4-2001 Q3-2001 Q2-2001 Q1-2001 Q4-2000
------------- ------------ ------------ ------------ ------------ ------------ ------------ -----------
Revenue
Design Implementation 45% 42% 40% 42% 39% 39% 38% 40%
Verification and Test 26 34 37 33 34 32 31 30
Design Analysis 17 6 6 6 6 5 7 5
IP 6 9 9 10 10 9 10 11
Professional Services 6 9 8 9 11 15 14 14
------------- ------------ ------------ ------------ ------------ ------------ ------------ -----------
Total Company 100% 100% 100% 100% 100% 100% 100% 100%
============= ============ ============ ============ ============ ============ ============ ===========
22
DESIGN IMPLEMENTATION. Design Implementation includes products used for the
design of a chip from a high level functional description to a complete
description of the transistors and wires that implement such functions that can
be delivered to a semiconductor company for manufacturing (a process often
referred to as "RTL to GDSII"), including synthesis, physical synthesis, floor
planning and place-and-route products and technologies. The principal products
in this category are Design Compiler, FPGA Compiler, Physical Compiler, Chip
Architect, Floorplan Compiler, Jupiter, Apollo, Astro and related products.
Design Implementation, as a percent of revenue, fluctuated between 38% and 42%
in the period from the fourth quarter of fiscal 2000 through the second quarter
of fiscal 2002, and exhibited a generally increasing trend from the first
quarter of fiscal 2001 through the second quarter of fiscal 2002. This trend
reflects the Company's growing portfolio of Design Implementation products
during the period, most notably the introduction of Physical Compiler, and the
growing importance of design implementation products in solving customers design
problems. The 3% increase from the second quarter of fiscal 2002 to the third
quarter of fiscal 2002 is due principally to the addition of Avant! products to
this category, since the largest portion of Avant!'s revenue was derived from
products (including its principal place and route products) that were added to
the Design Implementation category.
VERIFICATION AND TEST. Verification and Test includes products used for
verification and analysis performed at the system level, register transfer level
(RTL) and gate level of design, including simulation, system level design and
verification, timing analysis, formal verification, test and related products.
The principal products in this category are VCS, Polaris, Vera, PathMill,
CoCentric System Studio, PrimeTime, Formality, Design Verifyer, DFT Compiler and
TetraMax. As a percent of revenue, revenue from this product family fluctuated
between 30% and 34% in the period from the fourth quarter of fiscal 2000 through
the second quarter of fiscal 2002, principally attributable to the mix of
perpetual versus time-based license orders received for Verification and Test
products during any given quarter. Revenue as a percent of total revenue
increased through the second quarter of fiscal 2002 as a result of the quarterly
amortization of deferred revenue related to the ratable license model. From the
second quarter of fiscal 2002 to the third quarter of fiscal 2002, Verification
and Test revenues as a percent of total Company revenue decreased, principally
because the Verification and Test product group does not include many products
acquired from Avant!. In terms of absolute dollars, revenues from this product
group remained relatively flat.
DESIGN ANALYSIS. Design Analysis includes products used for verification and
analysis performed at the transistor level and physical level of design,
including analog and mixed signal circuit simulation, design rule checking,
power analysis, customer design, semiconductor process modeling and reliability
analysis. The principal products in this category are NanoSim, StarSim, HSPICE,
StarRC, Arcadia, TCAD, Hercules, Venus, OPC, PrimePower and Cosmos. Revenue from
this product group as a percentage of total revenues has ranged between 5% and
7% since the introduction of TSLs as a result of the mix of perpetual versus
time-based license orders received during a particular quarter. During the third
quarter of fiscal 2002, revenue from this product group as a percentage of total
revenues increased to 17%, due primarily to the Avant! acquisition, as the
second largest portion of Avant!'s revenue was derived from products that were
added to the Design Analysis category.
INTELLECTUAL PROPERTY. Our IP products include the DesignWare library of
design components and verification models. Revenue as a percent of total revenue
decreased from the fourth quarter of fiscal 2000 to the third quarter of fiscal
2002 from 11% to 6%, respectively, due in part to the fact that the term of many
of these licenses has increased from one to three years and the revenue is
recognized over a longer period of time. From the second quarter of fiscal 2002
to the third quarter of fiscal 2002, IP revenues as a percent of total Company
revenue decreased principally because the IP product group does not include many
products acquired from Avant!
PROFESSIONAL SERVICES. The Professional Services group includes consulting
and training activities. This group provides consulting services, including
design methodology assistance, specialized telecommunications systems design
services and turnkey design. Revenue from professional services as a percentage
of total revenues has declined from 14% in the fourth quarter of fiscal 2000 to
6% in the third quarter of fiscal 2002, reflecting, as described above under
"Revenue", the impact of the economic environment.
COST OF REVENUE. Cost of revenue consists of the cost of product revenue,
cost of service revenue and cost of ratable license revenue and amortization of
intangible assets and deferred stock compensation. Cost of product revenue
includes personnel and related costs, production costs, product packaging,
documentation, amortization of capitalized software development costs and
purchased technology, and costs of the components of our hardware system
products. The cost of internally developed capitalized software is amortized
based on the greater of the ratio of current product revenue to the total of
current and anticipated product revenue or the straight-line method over the
23
software's estimated economic life of approximately two years. Cost of service
revenue includes consulting services, personnel and related costs associated
with providing training and PCS on perpetual licenses. Cost of ratable license
revenue includes the costs of product and services related to our TSLs, since
TSLs include bundled product and services. Cost of product revenue, cost of
service revenue and cost of ratable license revenue are heavily dependent on an
on the mix of software orders received during the period.
Cost of product revenue decreased to 7% of total product revenue for the
three months ended July 31, 2002 compared to 14% for the same period during
2001. Cost of product revenue was 8% and 15% for the nine months ended July 31,
2002 and 2001, respectively. This decrease in cost of product revenue as a
percentage of total product revenue for the three- and nine-month periods ended
July 31, 2002 as compared to 2001 is due in part to the wind-down of our
internet business unit during the third quarter of fiscal 2001, and in part to
certain direct costs related to commitments that were incurred during the third
quarter of fiscal 2001 resulting from the sale of our silicon libraries
business.
Cost of service revenue as a percentage of total service revenue was 27% and
24% for the third quarters of fiscal 2002 and 2001, respectively, and increased
to 28% from 22% for the nine months ended July 31, 2002 and 2001, respectively.
The increase in cost of service revenue as a percentage of total service revenue
is due primarily to the decline in total service revenue and to decreased
utilization of our professional services personnel, both as a result of the
economic environment.
Cost of ratable license revenue was 10% in the third quarter of fiscal 2002
compared to 15% for the third quarter of 2001 and was 15% and 16% for the nine
months ended July 31, 2002 and 2001, respectively. The cost of ratable license
revenue as a percent of ratable revenue is impacted by the mix of orders between
product, service and ratable revenue during the particular quarter as well as an
increase in quarterly amortization of deferred revenue and backlog, which is an
inherent result of the use of the ratable license model.
Amortization of intangible assets and deferred stock compensation includes
the amortization of the contract rights intangible asset associated with certain
executory contracts, as discussed under "ACQUISITION OF AVANT! CORPORATION"
below, and the amortization of core/developed technology acquired in the Avant!
merger. Total amortization of these intangible assets for the three- and
nine-month periods ended July 31, 2002 was $2.7 million and $10.2 million,
respectively. In connection with the Avant! acquisition, the Company also
assumed unvested stock options held by Avant! employees. The Company has
recorded deferred stock compensation totaling $8.1 million based on the
intrinsic value of these assumed unvest