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EXCEL - IDEA: XBRL DOCUMENT - MAGMA DESIGN AUTOMATION INCFinancial_Report.xls
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MAGMA DESIGN AUTOMATION INCa10qq22012ex311.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - MAGMA DESIGN AUTOMATION INCa10qq22012ex312.htm
EX-32.2 - CERTIFICATE OF CHIEF FINANCIAL OFFICER - MAGMA DESIGN AUTOMATION INCa10qq22012ex322.htm
EX-32.1 - CERTIFICATE OF CHIEF EXECUTIVE OFFICER - MAGMA DESIGN AUTOMATION INCa10qq22012ex321.htm
EX-10.35 - 10.35 AMENDMENT NUMBER FIVE TO CREDIT AGREEMENT AND CONSENT DATED OCTOBER 19, 2011, BY AND BETWEEN THE LENDERS IDENTIFIED, THEREIN, THE REGISTRANT AND WELLS FARGO CAPITAL FINANCE - MAGMA DESIGN AUTOMATION INCa1035amendmentnumberfivewe.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________ 
FORM 10-Q
 _____________________________________________ 
(Mark One)
S
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 30, 2011
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 No.: 0-33213
_______________________________________________ 
MAGMA DESIGN AUTOMATION, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________
Delaware
 
77-0454924
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1650 Technology Drive,
San Jose, California 95110
(Address of principal executive offices)
Telephone: (408) 565-7500
(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 at least the past 90 days.    Yes  S No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  S    No  £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer  £
 
Accelerated Filer  x
Non-accelerated Filer  £    (Do not check if a smaller reporting company)
 
Smaller reporting company  £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes £   No  S
The number of shares outstanding of the registrant’s Common Stock, par value $0.0001, as of December 6, 2011 was 69,140,270.


MAGMA DESIGN AUTOMATION, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED OCTOBER 30, 2011
INDEX
 
 
 
Page
 
Condensed Consolidated Balance Sheets at October 30, 2011 and May 1, 2011
 
Condensed Consolidated Statements of Operations for the Three and Six Months Ended October 30, 2011 and, October 31, 2010
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended October 30, 2011 and, October 31, 2010
 
 
 
 
 
 
 
 
 
 
 
 
 


1


PART 1: FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

MAGMA DESIGN AUTOMATION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
 
 
October 30,
2011
 
May 1,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
50,809

 
$
47,088

Accounts receivable, net including receivables from related parties of $875 and $2,181 at October 30, 2011 and May 1, 2011, respectively
24,377

 
35,530

Prepaid expenses and other current assets
4,176

 
3,915

Total current assets
79,362

 
86,533

Property and equipment, net
5,700

 
6,066

Intangible assets, net
2,351

 
3,691

Goodwill
7,415

 
7,415

Other assets
2,604

 
2,767

Total assets
$
97,432

 
$
106,472

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,133

 
$
3,697

Accrued expenses
12,934

 
14,160

Current portion of term debt
1,875

 
3,750

Current portion of other long-term liabilities
1,083

 
1,199

Deferred revenue
21,528

 
34,390

Total current liabilities
40,553

 
57,196

Convertible notes, net of debt premium of $122 and $145 at October 30, 2011 and May 1, 2011, respectively
3,372

 
3,395

Long-term portion of term debt
19,500

 
19,188

Long-term tax liabilities
1,814

 
1,703

Other long-term liabilities
979

 
1,270

Total liabilities
66,218

 
82,752

Commitments and contingencies (Note 12)

 

Stockholders' equity:
 
 
 
Common stock
7

 
7

Additional paid-in capital
452,555

 
447,328

Accumulated deficit
(384,199
)
 
(387,087
)
Treasury stock at cost
(32,615
)
 
(32,615
)
Accumulated other comprehensive loss
(4,534
)
 
(3,913
)
Total stockholders' equity
31,214

 
23,720

Total liabilities and stockholders' equity
$
97,432

 
$
106,472


See accompanying notes to unaudited condensed consolidated financial statements.


2


MAGMA DESIGN AUTOMATION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Revenue*:
 
 
 
 
 
 
 
Licenses
$
31,551

 
$
26,903

 
$
58,108

 
$
51,242

Services
6,732

 
7,023

 
15,481

 
15,240

Total revenue
38,283

 
33,926

 
73,589

 
66,482

Cost of revenue*:
 
 
 
 
 
 
 
Licenses
542

 
998

 
1,161

 
1,934

Services
4,011

 
4,065

 
8,011

 
7,871

Total cost of revenue
4,553

 
5,063

 
9,172

 
9,805

Gross profit
33,730

 
28,863

 
64,417

 
56,677

Operating expenses:
 
 
 
 
 
 
 
Research and development
12,698

 
11,747

 
25,483

 
24,006

Sales and marketing
11,481

 
11,319

 
21,891

 
21,886

General and administrative
5,218

 
4,625

 
11,389

 
9,315

Amortization of intangible assets
149

 
289

 
351

 
545

Restructuring charges
520

 
182

 
1,246

 
168

Total operating expenses
30,066

 
28,162

 
60,360

 
55,920

Operating income
3,664

 
701

 
4,057

 
757

Other income (expense):
 
 
 
 
 
 
 
Interest income
23

 
20

 
37

 
49

Interest expense
(454
)
 
(537
)
 
(936
)
 
(1,343
)
Valuation gain, net

 

 

 
38

Loss on extinguishment of debt

 

 

 
(2,093
)
Inducement fees on conversion of notes

 
(2,279
)
 

 
(2,279
)
Other income (expense), net
158

 
(712
)
 
552

 
(863
)
Other expense, net
(273
)
 
(3,508
)
 
(347
)
 
(6,491
)
Net income (loss) before income taxes
3,391

 
(2,807
)
 
3,710

 
(5,734
)
Benefit from (provision for) income taxes
(403
)
 
93

 
(823
)
 
(238
)
Net Income (loss)
$
2,988

 
$
(2,714
)
 
$
2,887

 
$
(5,972
)
Net income (loss) per share, basic
$
0.04

 
$
(0.04
)
 
$
0.04

 
$
(0.11
)
Net income (loss) per share, diluted
$
0.04

 
$
(0.04
)
 
$
0.04

 
$
(0.11
)
Shares used in per share calculation, basic
68,458

 
60,542

 
68,121

 
56,553

Shares used in per share calculation, diluted
72,947

 
60,542

 
71,410

 
56,553



* Revenue and cost of revenue for the three and six months ended October 31, 2010 have been adjusted to conform with the presentation for the three and six months ended October 30, 2011. See Note 1 for further discussion.


See accompanying notes to unaudited condensed consolidated financial statements


3


MAGMA DESIGN AUTOMATION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
Cash flows from operating activities:
 
 
 
Net Income (loss)
$
2,887

 
$
(5,972
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation
1,966

 
2,397

Amortization of intangible assets
1,381

 
2,203

Provision for doubtful accounts
225

 

Amortization of debt discount and debt issuance costs
126

 
449

Amortization of debt premium
(23
)
 
(287
)
Loss on extinguishment of convertible notes

 
2,093

Inducement fee on conversion of convertible notes

 
2,279

(Gain)/Loss on strategic equity investments
(470
)
 
65

Stock-based compensation
4,890

 
6,569

Restructuring charges
1,246

 
168

Other non-cash items
3

 
67

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
10,445

 
1,685

Prepaid expenses and other assets
(216
)
 
214

Accounts payable
(562
)
 
(988
)
Accrued expenses
(2,702
)
 
(5,264
)
Deferred revenue
(12,996
)
 
(1,442
)
Other long-term liabilities
211

 
(160
)
Net cash provided by operating activities
6,411

 
4,076

Cash flows from investing activities:
 
 
 
Cash paid for purchased technology and acquisition related earnouts
(40
)
 
(599
)
Purchase of property and equipment
(1,122
)
 
(457
)
Proceeds from maturities and sale of investments

 
16,875

Sale/(Purchase) of strategic investments
518

 
(275
)
Net cash provided by (used in) investing activities
(644
)
 
15,544

Cash flows from financing activities:
 
 
 
Repayment of lease obligations
(875
)
 
(1,151
)
Repayment of secured credit line

 
(11,162
)
Repayment of convertible notes due 2010

 
(23,250
)
Repurchase of convertible notes due 2014

 
(4,839
)
Repayment of term debt
(1,563
)
 
(563
)
Proceeds from term debt

 
10,000

Payment of financing fee related to term debt

 
(100
)
Payment of inducement fee on conversion of convertible notes due in 2014

 
(2,279
)
Proceeds from issuance of common stock, net
3,776

 
1,766

Repurchase of common stock for retirement
(2,003
)
 
(1,960
)
Retirement of restricted stock
(1,403
)
 
(993
)
Net cash used in financing activities
(2,068
)
 
(34,531
)
Effect of foreign currency translation changes on cash and cash equivalents
22

 
41

Net change in cash and cash equivalents
3,721

 
(14,870
)
Cash and cash equivalents, beginning of period
47,088

 
57,518

Cash and cash equivalents, end of period
$
50,809

 
$
42,648

Supplemental disclosure of cash flow information
 
 
 
Non-cash investing financing activities:
 
 
 
Purchase of equipment under capital leases
$
367

 
$
932


See accompanying notes to unaudited condensed consolidated financial statements.


4


MAGMA DESIGN AUTOMATION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1.    Basis of Presentation
The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Magma Design Automation, Inc. (“Magma” or the “Company”) pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for interim period financial reporting. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to these rules and regulations. However, management believes that the disclosures are adequate to ensure that the information presented is not misleading. The condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to present a fair statement of results and financial position for the interim periods presented. The operating results for any interim period are not necessarily indicative of the results that may be expected for the entire fiscal year ending April 29, 2012. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended May 1, 2011, as amended. The accompanying unaudited condensed consolidated balance sheet at May 1, 2011 is derived from audited consolidated financial statements at that date.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements of Magma include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Accounts denominated in foreign-currencies have been translated from their functional currency to the U.S. dollar.
Reclassifications
Certain immaterial amounts on the statement of cash flows for the six months ended October 31, 2010, have been reclassified to conform to the six months ended October 30, 2011 presentation.
Reclassification of Revenue and Cost of Revenue
Beginning with the first quarter of fiscal 2012, revenue and cost of revenue is reported in Magma's condensed consolidated statements of operations in two categories: licenses and services. Previously, revenue and cost of revenue were reported in three categories: licenses, bundled licenses and services, and services. Magma management has concluded that the results of the bundled licenses and services category of revenue do not indicate a material trend in the historical or future performance of the Company's operations. Bundled licenses and services revenue and cost of revenue are divided into their component parts and included with either licenses or services. The Company allocates the established vendor specific objective evidence ("VSOE") for services included in bundled licenses contracts to the services revenue category in the condensed consolidated statement of operations. Presentation of prior period revenue and cost of revenue has been adjusted to conform to the current period.
This change for financial reporting purposes conforms to the presentation of revenue and cost of revenue for management reporting and analysis purposes in Magma's Management's Discussion and Analysis of Financial Condition and Results of Operations since the third quarter of fiscal 2009. Previously, for financial reporting purposes, bundled licenses and services revenue was presented as a category of revenue to reflect Magma's revenue recognition policy. The Company offers various contractual terms in designing license agreements to accommodate customer preferences, which are unrelated to product performance and service requirements, order volume, or pricing. The contractual terms that result in the recognition of bundled licenses and services revenue are subject to customer preferences and have historically been inconsistently elected by customers. Moreover, revenue from existing long term contracts shifted between revenue categories, with no change in the aggregate revenues recognized from such contracts. Because customers can choose to purchase the same products in either bundled or unbundled arrangements, under the former presentation, customer choices in any quarter created the appearance of volatility that did not reflect the underlying substance. Separating the bundled contracts into their respective components of licenses and services will more clearly reflect the results of revenues by removing the distorting effects of changing customer preferences. Finally, the former presentation and disclosure was inconsistent with the presentation practice of Magma's main competitors, which inhibited comparability, relevance and usefulness to users of the financial statements for the purposes of making investment decisions. Therefore, management has concluded that the bundled license and service revenue category does not indicate a material trend in the Company's historical or future performance.

5



Recently issued accounting pronouncements
 In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05, “Comprehensive Income (Topic 220)—Presentation of Comprehensive Income” (“ASU 2011-05”), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011 and should be applied retrospectively. Magma does not expect the adoption of ASU 2011-05 to have a significant effect on its consolidated financial statements.    
 In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which amends ASC 820, “Fair Value Measurement,” (“ASU 2011-04”). The amended guidance changes the wording used to describe many requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Additionally, the amendments clarify FASB’s intent about the application of existing fair value measurement requirements. The guidance provided in ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is applied prospectively. Magma does not expect the adoption of these provisions to have a significant effect on its consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment," which simplifies how entities test goodwill for impairment. The amended guidance permits an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit in which goodwill resides is less than its carrying value. For reporting units in which this assessment concludes it is more likely than not that the fair value is more than its carrying value, the amended guidance eliminates the requirement to perform further goodwill impairment testing as outlined in the previously issued standards. The updated guidance is elective for annual and interim impairment tests performed beginning with the Company's fiscal year 2013 and early adoption is permitted. Magma does not expect the new guidance to significantly impact its consolidated financial statements.
Note 2.    Fair Value Option
During the second quarter of fiscal 2009, the Company elected fair value accounting for the purchased put option recorded in connection with the Auction Rate Securities (“ARS”) settlement agreement signed with UBS Financial Services, Inc. (“UBS”) (see Note 3 “Fair Value of Financial Instruments”). This election was made in order to mitigate volatility in earnings caused by accounting for the purchased put option and underlying ARS under different methods. Fair value accounting led to a gain of $38,000 on the exercise of the purchased put option for the six months ended October 31, 2010, which is included in “Valuation gain, net” in the Company's condensed consolidated statement of operations.
Note 3.    Fair Value of Financial Instruments
The Company measures assets and liabilities carried at fair value. These assets and liabilities are classified and disclosed in one of the following three levels:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The following table is a reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) during the six months ended October 30, 2011 and October 31, 2010 (in thousands):
 
 
Six Months Ended
 
 
October 30,
2011
 
October 31,
2010
Beginning balance
  
$

 
$
16,837

Net sales and settlements
 

 
(16,875
)
Gain on put option
 

 
38

Ending balance
 
$

 
$



6


Cash and cash equivalents are included in the consolidated balance sheets as follows (in thousands):
 
 
Cost
Gross
Realized
Gains
Gross Realized Losses
Estimated Fair Value
October 30, 2011
  
 
 
 
Cash (U.S. and international)
$
50,809



$
50,809

 
  
 
 
 
May 1, 2011
  
 
 
 
Cash (U.S. and international)
$
47,088



$
47,088


Note 4.    Basic and Diluted Net Income (Loss)
The Company computes net income (loss) per share by dividing net income (loss) ("numerator") by the weighted average number of common shares outstanding ("denominator") during the period. Diluted net income (loss) per share is impacted by equity instruments considered to be potential common shares, if dilutive, computed using the “treasury stock” method of accounting. Potentially dilutive common shares outstanding include shares issuable under the Company’s stock-based compensation plans such as stock options, restricted stock and restricted stock units, and under the Company's employee stock purchase plan, as well as shares issuable upon conversion of redeemable convertible notes.
A summary of weighted average shares used in basic and diluted net income (loss) per share is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Numerator
 
 
 
 
 
 
 
     Net income (loss)
$
2,988

 
$
(2,714
)
 
$
2,887

 
$
(5,972
)
Denominator
 
 
 
 
 
 
 
     Weighted-average common shares for basic net income (loss)
68,458

 
60,542

 
68,121

 
56,553

  Dilutive effect of common shares equivalents from stock-based compensation plans
2,683

 

 
3,289

 

     Dilutive effect of common shares equivalents upon conversion of 2014 Notes
1,806

 

 

 

     Weighted-average common shares for diluted net income (loss) per share
72,947

 
60,542

 
71,410

 
56,553

 
 
 
 
 
 
 
 
Net income (loss) per share- basic
$
0.04

 
$
(0.04
)
 
$
0.04

 
$
(0.11
)
Net income (loss) per share- diluted
$
0.04

 
$
(0.04
)
 
$
0.04

 
$
(0.11
)
Certain shares issuable under stock options, restricted stock, restricted stock units and the employee stock purchase plan were excluded from the computation of diluted net income (loss) per share in periods when their effect was anti-dilutive either because the Company incurred a net loss for the period, the exercise price of the options was greater than the average market price of the common stock during the period, or the effect was anti-dilutive as a result of applying the “treasury stock” method. In addition, certain common shares issuable upon conversion of convertible notes were excluded from the computation of diluted net loss per share because their effect was anti-dilutive as a result of applying the “if converted” method.
A summary of the potential common shares excluded from diluted net income (loss) per share is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Shares of common stock issuable under Company’s stock-based compensation plans
4,041

 
11,566

 
3,508

 
11,543

Shares of common stock issuable upon conversion of convertible notes

 
6,043

 
1,806

 
10,217


7



Note 5.    Balance Sheet Components
Significant components of certain balance sheet items were as follows (in thousands):
 
 
October 30,
2011
 
May 1,
2011
Accounts receivable, net:
 
 
 
Trade accounts receivable, including receivables from related parties of $875 and $2,181 at October 30, 2011 and May 1, 2011, respectively
$
14,441

 
$
26,750

Unbilled receivables
10,161

 
8,939

Gross accounts receivable
24,602

 
35,689

Allowance for doubtful accounts
(225
)
 
(159
)
Total accounts receivable, net
$
24,377

 
$
35,530

Accrued expenses:
 
 
 
Accrued sales commissions
$
2,133

 
$
1,160

Accrued bonuses
605

 
4,013

Other payroll and related accruals
6,149

 
5,219

Acquisition accrual
60

 
60

Accrued professional fees
601

 
368

Income taxes payable
403

 
326

Restructuring accrual
141

 
769

Other
2,842

 
2,245

Total accrued expenses
$
12,934

 
$
14,160

Note 6.    Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consisted of the following (in thousands):
 
October 30,
2011
 
May 1,
2011
Foreign currency translation adjustments
$
4,534

 
$
3,913

Note 7.    Acquisitions
The Company did not make any acquisitions during the six months ended October 30, 2011.
Acquisition-related earnouts and purchase of licensed technology
For a number of Magma’s previously completed acquisitions, the Company agreed to pay contingent consideration to former stockholders of the acquired companies based on the acquired businesses’ achievement of certain technology or financial milestones. The following table summarizes the amounts of goodwill and intangible assets recorded by the Company for contingent consideration paid or payable to former stockholders of the acquired companies and in connection with the purchase of licensed technology (in thousands):
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
Goodwill:
 
 
 
Sabio Labs, Inc.
$

 
$
7

Total goodwill

 
7

Intangible assets:
 
 
 
Licensed Technology
40

 
310

Total intangible assets
40

 
310

Total earnout consideration
$
40

 
$
317

As of October 30, 2011, there were no outstanding earnouts on any of the previously acquired companies.

8


Note 8.    Goodwill and Intangible Assets
The following table summarizes the components of goodwill, other intangible assets and related accumulated amortization balances, which were recorded as a result of business combinations and asset purchases (in thousands):
 
 
 
October 30, 2011
 
May 1, 2011
 
Average
Life
(months)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Goodwill
 
 
$
7,415

 
$

 
$
7,415

 
$
7,415

 
$

 
$
7,415

Other intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
43

 
$
115,536

 
$
(114,727
)
 
$
809

 
$
115,496

 
$
(114,237
)
 
$
1,259

Licensed technology
40

 
42,356

 
(42,073
)
 
283

 
42,356

 
(41,480
)
 
876

Customer relationship or base
70

 
5,575

 
(4,766
)
 
809

 
5,575

 
(4,505
)
 
1,070

Acquired customer contracts
33

 
1,390

 
(1,090
)
 
300

 
1,390

 
(1,089
)
 
301

Trademark
67

 
900

 
(750
)
 
150

 
900

 
(715
)
 
185

Total
 
 
$
165,757

 
$
(163,406
)
 
$
2,351

 
$
165,717

 
$
(162,026
)
 
$
3,691

During the six months ended October 30, 2011, the Company acquired developed technology for an amount equal to $40,000. During the same period there were no purchase price adjustments related to acquired businesses.
Goodwill is reviewed annually or whenever events or circumstances occur which indicate that goodwill might be impaired. The Company uses a two-step approach to determining whether and by how much goodwill has been impaired. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment. In estimating the fair value of the Company, the Company made estimates and judgments about future revenues and cash flows for its reporting unit.
To determine the fair value of a reporting unit, the Company uses a market approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of the Company's common stock. The first step requires a comparison of the fair value of the Company (reporting unit) to its net book value. If the fair value is greater than net book value, no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual impairment. The Company uses the income method for the second step. The income method is based on a discounted future cash flow approach that uses estimates including the following for the reporting unit: revenue, based on assumed market growth rates and its assumed market share; estimated costs; and appropriate discount rates based on the particular business's weighted average cost of capital. The Company's estimates of market segment growth, market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates it uses to manage the underlying business. The Company's business consists of both established and emerging technologies and its forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information.
During fiscal 2011, the Company conducted its annual goodwill impairment test at December 31, 2010, using the market approach for the first step. At December 31, 2010, the Company determined that the fair value of its reporting unit is greater than the book value of the net assets of the reporting unit and therefore concluded there is no impairment of goodwill.
During the six months ended October 30, 2011, there were no triggering events that would indicate an impairment and cause the Company to conduct an impairment test.
The Company has included the amortization expense on intangible assets that relate to products sold in cost of revenue, while the remaining amortization is shown as a separate line item on the Company’s condensed consolidated statements of operations. The amortization expense related to intangible assets was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Amortization of intangible assets included in:
 
 
 
 
 
 
 
Cost of revenue
$
492

 
$
833

 
$
1,030

 
$
1,658

Operating expenses
149

 
289

 
351

 
545

Total
$
641

 
$
1,122

 
$
1,381

 
$
2,203

As of October 30, 2011, the estimated future amortization expense of intangible assets in the table above was as follows (in thousands):

9


 
Fiscal Year
Estimated
Amortization
Expense
2012 (remaining six months)
$
725

2013
1,147

2014
306

2015
126

2016 and thereafter
47

 
$
2,351

Note 9.    Convertible Notes, Current and Long-Term
The Company’s 2% Convertible Senior Notes due 2010 (the “2010 Notes”) matured on May 15, 2010. These notes bore interest at 2% per annum, with interest payable on May 15 and November 15 of each year since 2007. During the first quarter of fiscal 2011, the Company paid the remaining principal balance and the outstanding interest on the 2010 Notes of approximately $23.2 million.
On September 11, 2009, the Company completed an exchange offer pursuant to which an aggregate principal amount of $26.7 million of its 2010 Notes were exchanged for $26.7 million aggregate principal amount of newly issued 6% Convertible Senior Notes due 2014 (the “2014 Notes”). Because the terms of the 2014 Notes were substantially different from the 2010 Notes, the exchange offer was treated as an extinguishment of the $26.7 million principal amount of the 2010 Notes. The Company initially recorded the 2014 Notes at fair value of $28.5 million, including a debt premium of $1.8 million. The debt premium is being amortized to interest expense over the term of the 2014 Notes. A total of $1.9 million of underwriting and legal fees related to the 2014 Notes offering was capitalized upon issuance and is being amortized over the term of the 2014 Notes using the effective interest method.
The 2014 Notes mature on May 15, 2014 and bear interest at 6% per annum, with interest payable on May 15 and November 15 of each year, commencing May 15, 2010. The 2014 Notes are convertible into shares of the Company's common stock at an initial conversion price of $1.80 per share. Except in limited specific circumstances related to a change in control (which includes consummation of the proposed merger transaction with Synopsys, Inc. (“Synopsys”) described in Note 18 “Subsequent Events”), holders will not receive a cash settlement; therefore, the Company is not required to separately account for the liability and equity components on the 2014 Notes. The 2014 Notes are unsecured senior indebtedness of Magma, which rank equally in right of payment to Magma's credit facility with Wells Fargo Capital Finance, LLC (see Note 10 “Term Loan and Revolving Loans”). The 2014 Notes are effectively subordinated in right of payment to the Wells Fargo credit facility to the extent of the security interest held by Wells Fargo Bank in the assets of the Company. After May 15, 2013, the Company has the option to redeem the 2014 Notes for cash in an amount equal to 100% of the aggregate outstanding principal amount at the time of such redemption.
During the first quarter of fiscal 2011, the Company repurchased an aggregate principal amount of $2.75 million of the 2014 Notes for $4.8 million in cash. A loss on extinguishment of the 2014 Notes of $2.1 million is accounted for in the condensed consolidated statements of operations as “Loss on extinguishment of debt.”
During the second quarter of fiscal 2011, the Company engaged in separately negotiated transactions with certain holders of its 2014 Notes to convert outstanding 2014 Notes to common stock. Pursuant to those transactions, the holders converted an aggregate principal amount of $20.7 million of the 2014 Notes into 11.5 million shares of the Company’s common stock. The 2014 Notes were converted at $1.80 per share per the initial indenture agreement at issuance. On conversion of the notes, the Company incurred $2.3 million in inducement fees, which were accounted for in the condensed statements of operations.
As of October 30, 2011, approximately $3.25 million of the 2014 Notes remained outstanding and are convertible into approximately 1.8 million shares of our common stock.
The following table summarizes the Company’s carrying values and market-based fair values of these financial instruments as of October 30, 2011 and May 1, 2011 (in thousands):
 
Carrying
Value
 
Estimated
Fair Value
October 30, 2011
 
 
 
Convertible senior notes due 2014
$
3,250

 
$
10,586

May 1, 2011
 
 
 
Convertible senior notes due 2014
$
3,250

 
$
12,065


10


Note 10.    Term Loan and Revolving Loans
On March 19, 2010, the Company entered into a new four year credit facility with Wells Fargo Capital Finance, LLC, (as amended, the “New Credit Facility”), which replaced the Company's $15.0 million secured revolving line of credit facility with Wells Fargo Bank, N.A. (the “Credit Facility”). The New Credit Facility provides for a revolving loan not to exceed $15.0 million and a term loan of $15.0 million (“Term Loan A”). The New Credit Facility is secured by a first priority security interest in all of the Company's assets. The Company subsequently executed three amendments in order to clarify certain administrative and operational aspects of the New Credit Facility. The amendments were executed in June 2010, July 2010 and September 2010, respectively, and did not materially alter the terms and conditions of the New Credit Facility. In October 2010, the Company executed a fourth amendment, which expanded the New Credit Facility with an additional term loan of $10.0 million (“Term Loan B”) and extended the maturity date to October 2014. In addition, on October 19, 2011, the Company executed a fifth amendment, which changed the LIBOR rate margin on Term Loan A as described below to 3.00% per annum and amended the repayment of quarterly installments for Term Loan A and Term Loan B as described below.
Under the New Credit Facility, beginning October 31, 2010, repayments of Term Loan A became payable in equal quarterly installments of $0.6 million and, in connection with the fifth amendment, such quarterly installment repayments decreased to $0.4 million effective October 31, 2011. Beginning April 30, 2011, repayments of Term Loan B became payable in equal quarterly installments of $0.4 million and, in connection with the fifth amendment, such quarterly installment repayments decreased to $0.3 million effective October 31, 2011. Under the terms of the New Credit Facility, outstanding borrowings and letter of credit liabilities may not, at any time, exceed the greater of $40.0 million or 50% of all “post-contract support” revenues and “time based license fee” revenues for the preceding twelve-month period. These requirements could limit, but to date have not limited, the Company's borrowing availability.
The revolving loan and Term Loan A bear interest at either a LIBOR rate or a base rate, at management's election, in each case determined as follows (plus a LIBOR rate margin of 4.5% until October 1, 2011 and 3.0% after October 1, 2011): (A) if at a LIBOR rate, at a per annum rate equal to the greater of (i) 1.00% per annum and (ii) the one, two or three month LIBOR rate quoted by Bloomberg and (B) if at the base rate, the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the three month LIBOR rate plus 1.0% and (iii) the Wells Fargo prime rate. Term Loan B bears interest at either a LIBOR rate or a base rate, at management's election, in each case determined as follows (plus a LIBOR rate margin of 3.0%): (A) if at a LIBOR rate, at a per annum rate equal to the greater of (i) 1.0% per annum and (ii) the one, two or three month LIBOR rate quoted by Bloomberg and (B) if at the base rate the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the three month LIBOR rate plus 1.0% and (iii) the Wells Fargo prime rate. In addition, the Company is required to pay fees of 0.5% per annum on the unused amount of the New Credit Facility, and 2.5% per annum for each letter of credit issued and quarterly administrative fees of $10,000.
The Company is required to pay interest and fees monthly, with the outstanding principal amount plus all accrued but unpaid interest and fees payable in full at the maturity date of October 29, 2014.
The New Credit Facility contains covenants that limit the Company's ability to create liens, merge, consolidate, dispose of assets, incur indebtedness and guarantees, repurchase or redeem capital stock and indebtedness, make certain investments, acquisitions and capital expenditures, enter into certain transactions with affiliates, change the nature of the Company's business or cause or permit to exist any change of control (which includes consummation of the proposed merger transaction with Synopsys described in Note 18 “Subsequent Events”). Events of default under the New Credit Facility include, but are not limited to, payment defaults, covenant defaults, breaches of representations and warranties, cross defaults to certain other material agreements and indebtedness, bankruptcy and other insolvency events, actual or asserted invalidity of security interests or loan documents.
The New Credit Facility also restricts the Company's ability to pay dividends or make other distributions on the Company's stock and requires that the Company comply with certain financial covenants.
As of October 30, 2011, there were letters of credit outstanding under the New Credit Facility of $2.1 million, which included two letters of credit totaling to $1.7 million as a security deposit on the Company's lease for its corporate facility and an additional letter of credit of $0.4 million in connection with an extension of the Company's lease agreement on September 28, 2011.
As of October 30, 2011, the Company had borrowed $25.0 million of term debt and repaid $3.6 million in total, including $2.6 million on Term Loan A and $1.0 million on Term Loan B. As of October 30, 2011, the unused amount of revolving loans under the New Credit Facility was $12.9 million. As of October 30, 2011, the Company was in compliance with the financial covenants contained in the New Credit Facility.

11



Note 11.    Restructuring charges
During the first quarter of fiscal 2012, the Company announced "SiliconOne", a major restructuring of its global go-to-market strategy. The change in direction of product strategy to differentiated integrated vertical solutions requires the sales teams to be able to present multiple-product platforms that integrate with customer design flows, rather than selling individual products, a strategy which the Company has relied upon since its founding. Because substantially different skill sets, along with changes to the structure and scope of the sales and marketing departments are required to support the implementation of the new strategy, the Company initiated a restructuring plan in the first quarter of fiscal 2012 ("FY 2012 Restructuring Plan").
The FY 2012 Restructuring Plan: (i) was approved and controlled by senior management; (ii) materially changed the manner in which the Company conducts its business; (iii) identified the number of positions and functions that were to be substantially modified, relocated or terminated; and (iv) identified the expected completion date for the changes required by the SiliconOne initiative. The Company determined that certain employees did not possess the capabilities and background necessary to support the SiliconOne initiative. As a result, some of these employees were terminated and paid severance during the first half of fiscal 2012, resulting in a charge of $1.3 million to restructuring expense in connection with the FY 2012 Restructuring Plan. No other type of restructuring charge related to the FY 2012 Restructuring Plan was recorded during the first half of fiscal 2012.
In connection with the FY 2012 Restructuring Plan, the Company expects to incur additional severance and relocation costs during the third quarter of fiscal 2012. An accrual for additional costs has not been recorded because liabilities had not been incurred, and the costs were not reasonably estimable at the end of the first half of fiscal 2012. Each severance and relocation arrangement under the FY 2012 Restructuring Plan is individually negotiated, and therefore the liability is not known until the offer is accepted by each employee. The FY 2012 Restructuring Plan is expected to be complete by the end of the third quarter of fiscal 2012.
In fiscal 2009, the Company initiated a restructuring plan (“FY 2009 Restructuring Plan”) designed to improve its cost structure and to better align its resources and improve operating efficiencies. In connection with the FY 2009 Restructuring Plan, the Company recorded a restructuring charge of $(0.1) million for the first quarter of fiscal 2012 related to a change in estimate for purchased software that was initially recorded at $0.7 million in the third quarter of fiscal 2011. The purchased software refers to the Company's legacy customer relationship management tool ("CRM tool"), which the Company was contractually obligated to license through January 30, 2012 (the third quarter of fiscal 2012). During the first quarter of fiscal 2012, the Company negotiated a $0.1 million reduction in the final annual license fee payable to the vendor of the CRM tool. Accordingly, the Company recorded a $0.1 million reduction to restructuring expense in the first quarter of fiscal 2012, the period the negotiations were completed. During the six months ended October 30, 2011, adjustments related to facilities and other costs of $0.1 million was recorded.
The restructuring liability activity was as follows (in thousands):
 
Severance
 
Facilities and
Other
 
Net
Liability
Balance at May 1, 2011
$
228

 
$
541

 
$
769

Restructuring provision
826

 
(100
)
 
726

Cash payments
(1,029
)
 
(382
)
 
(1,411
)
Balance at July 31, 2011
$
25

 
$
59

 
$
84

Restructuring provision
468

 
52

 
$
520

Cash payments
(382
)
 
(81
)
 
$
(463
)
Balance at October 30, 2011
$
111

 
$
30

 
$
141

Note 12.    Contingencies
The Company is subject to various legal proceedings and disputes that arise in the ordinary course of business from time to time. The number and significance of these legal proceedings and disputes may increase as the Company’s size changes. Any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. As a result, these legal proceedings and disputes could harm the Company’s business and have an adverse effect on its consolidated financial statements. However, the results of any litigation or dispute are inherently uncertain and, as of October 30, 2011, no estimate could be made of the loss or range of loss, if any, from such litigation matters and disputes. Liabilities are recorded when a loss is probable and the amount can be reasonably estimated. No accrued legal settlement liabilities are recorded on the condensed consolidated balance sheet as of October 30, 2011 or May 1, 2011. Litigation settlements and legal fees are expensed in the period in which they are incurred.
In Genesis Insurance Company v. Magma Design Automation, et al., Case No. 06-5526-JW, filed on September 8, 2006 in the United States District Court for the Northern District of California, Genesis seeks a declaration of its rights and obligations

12


under an excess directors and officers liability policy for defense and settlement costs arising out of the securities class action against the Company, as well as a related derivative lawsuit. Genesis seeks a return of $5.0 million it paid towards the settlement of the securities class action and derivative lawsuits from the Company or from another of the Company’s excess directors and officers liability insurers, National Union.
The Company contends that either Genesis or National Union owes the settlement amounts, but not the Company. The trial court granted summary judgment for the Company and National Union, finding that Genesis owed the settlement amount. Genesis appealed to the Ninth Circuit Court of Appeals, and the Company cross-appealed. On July 12, 2010, the Court of Appeals reversed, ruling that Genesis does not owe the settlement amount under its policy, and remanded the case to the trial court for further proceedings. On December 20, 2010, the trial ruled on various cross-motions that National Union owes the settlement amount to Genesis. The court entered a judgment in favor of Genesis and the Company on March 2, 2011, requiring that National Union pay $5.0 million plus prejudgment interest to Genesis. On April 1, 2011, National Union appealed the trial court's judgment to the Ninth Circuit Court of Appeals. National Union filed its opening brief on October 17, 2011 and the Company's reply brief is due December 12, 2011. While there can be no assurance as to the ultimate disposition of the litigation, the Company does not believe that its resolution will have a material adverse effect on the Company's financial position, results of operations or cash flows.
On September 30, 2011, Golden Gate Technology filed a complaint in the United States District Court for the Northern District of California (Case No. CV 11-04862) alleging that the Company infringes United States Patents Nos. 7,360,193 and 7,823,112 - Golden Gate Technology, Inc. v Magma Design Automation, United States District Court for the Northern District of California Action No. CV 11-04862.  The complaint was served on November 28, 2011 and Magma's answer is currently due on December 19, 2011. The Complaint identifies the Company's Talus product line as the alleged infringing instrumentality.  No trial date or pre-trial dates have been set.
On December 13, 2006 the Company initiated proceedings against Hubertus Maria Johannes Wilhelmus MULLENDERS, Kantoor Van den Boomen Beheer B.V., Kantoor Van den Boomen Accountants B.V., Kantoor Van den Boomen Salarisadviseurs B.V. Moore Stephens Van den Boomen B.V. in the District Court of in 's-Hertogenbosch in the Netherlands. The Company alleged that the defendants, who were providing accounting and taxation services to the Company, breached the duty of due care incumbent upon a reasonably competent and diligent professional acting in similar circumstances. On June 22, 2011, the court ordered Moore Stephens Van den Boomen to pay to Magma a sum of EUR 0.5 million to be increased by applicable statutory interest. On October 19, 2011, the Company, through counsel, received an amount of EUR 0.6 million or $0.9 million. Moore Stephens Van den Boomen is eligible to appeal the judgment and must file his statement of appeal no later than November 29, 2011, but is eligible for six week extensions under certain circumstances. After an appeal is filed, the Company will have six weeks to respond, subject to additional six week extensions under certain circumstances. Until a final judgment is granted the Company, there can be no assurances about ultimate disposition of the litigation. The cash received has accounted in other current liabilities on the condensed consolidated balance sheet as of October 30, 2011.
Indemnification Obligations
The Company enters into standard license agreements in the ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify its customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement claim by any third party with respect to the Company’s products. These indemnification obligations do not have a specific term. The Company’s normal business practice is to limit the maximum amount of indemnification to the amount received from the customer. On occasion, the maximum amount of indemnification the Company may be required to provide may exceed the amount received from the customer. The Company estimates the fair value of its indemnification obligations to be insignificant, based upon its historical experience concerning product and patent infringement claims. Accordingly, the Company has no liabilities recorded for indemnification under these agreements as of October 30, 2011.
The Company has agreements whereby its officers and directors are indemnified for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a directors’ and officers’ liability insurance policy that reduces its exposure and enables the Company to recover a portion of future amounts paid. As a result of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is insignificant. Accordingly, no liabilities have been recorded for these agreements as of October 30, 2011.
In connection with certain of the Company’s business acquisitions, the Company has also agreed to assume, or cause its subsidiaries to assume, the indemnification obligations of the acquired companies to their respective officers and directors. No liabilities have been recorded for these agreements as of October 30, 2011.
Warranties
The Company offers certain customers a warranty that its products will conform to the documentation provided with the products. To date, there have been no payments or material costs incurred related to fulfilling these warranty obligations.

13


Accordingly, the Company has no liabilities recorded for these warranties as of October 30, 2011. The Company assesses the need for a warranty accrual on a quarterly basis, and there can be no guarantee that a warranty accrual will not become necessary in the future.
Note 13.    Repurchase and Retirement of Common Stock
Effective January 31, 2011, the Company’s Board of Directors approved an increase in the Company’s stock buy-back program, authorizing the Company to purchase up to $30.0 million of its common stock, an increase of $10.0 million over the original authorization of $20.0 million announced in fiscal 2008.
During the second quarter of fiscal 2012, the Company used approximately $2.0 million to repurchase approximately 396,520 shares of its common stock in the open market. The repurchase prices ranged from $4.44 to $5.26 per share. The repurchased shares were retired immediately subsequent to the purchase.
During the first quarter of fiscal 2011, the Company used approximately $2.0 million to repurchase approximately 638,375 shares of its common stock in the open market. The repurchase prices ranged from $2.82 to $3.37 per share. The repurchased shares were retired immediately subsequent to the purchase.
Note 14.    Stock-Based Compensation
The stock-based compensation recognized in the consolidated statements of operations was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Cost of revenue
$
96

 
$
577

 
$
205

 
$
848

Research and development expense
983

 
1,103

 
1,855

 
2,338

Sales and marketing expense
536

 
1,140

 
1,187

 
1,865

General and administrative expense
1,049

 
765

 
1,643

 
1,518

Total stock-based compensation expense
$
2,664

 
$
3,585

 
$
4,890

 
$
6,569

The Company has adopted several stock incentive plans providing stock-based awards to employees, directors, advisors and consultants, including stock options, restricted stock and restricted stock units. The Company also has an Employee Stock Purchase Plan (“ESPP”), which enables employees to purchase shares of the Company’s common stock. Stock-based compensation expense by type of award was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Stock options
$
473

 
$
618

 
$
880

 
$
1,283

Restricted stock and restricted stock units
1,530

 
1,888

 
2,677

 
3,152

Employee stock purchase plan
661

 
1,079

 
1,333

 
2,134

Total stock-based compensation expense
$
2,664

 
$
3,585

 
$
4,890

 
$
6,569

Stock Options and Employee Stock Purchase Plan
The Company uses the Black-Scholes option pricing model to determine the fair value of its stock options and ESPP awards. The Black-Scholes option pricing model incorporates various highly subjective assumptions, including expected future stock price volatility and expected terms of instruments. The Company established the expected term for employee options and awards, as well as forfeiture rates, based on the historical settlement experience, while giving consideration to vesting schedules and to options that have life cycles less than the contractual terms. Assumptions for option exercises and pre-vesting terminations of options were stratified for employee groups with sufficiently distinct behavior patterns. For fiscal 2011, expected future stock price volatility was developed based on the average of the Company's historical daily stock price volatility and average implied volatility. For fiscal 2012, expected future stock price volatility was developed based on the average of the Company's historical daily stock price volatility. Due to significant changes in the Company's capital structure during fiscal 2011 and the lack of comparable traded option activity, management believes using historical daily stock price volatility exclusively for fiscal 2012 is a better basis for estimating future stock price volatility. The risk-free interest rate for the period within the expected life of the option is based on the yield of United States Treasury notes at the time of grant. The expected dividend yield used in the calculation is zero as the Company has not historically paid dividends.
The assumptions used in the Black-Scholes model and the weighted average grant date fair values per share were as follows:

14


 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Stock options:
 
 
 
 
 
 
 
Expected life (years)
3.98

 
3.90-3.98

 
3.96

 
3.90-4.00

Volatility
77
%
 
71
%
 
75%-77%

 
71
%
Risk-free interest rate
0.36%-0.54%

 
0.67%-0.86%

 
0.36%-1.00%

 
0.67%-1.53%

Expected dividend yield
%
 
%
 
%
 
%
Weighted average grant date fair value
$
2.90

 
$
1.79

 
$
3.16

 
$
1.73

ESPP awards:
 
 
 
 
 
 
 
Expected life (years)
1.13

 
1.13

 
1.13

 
1.13

Volatility
65
%
 
71
%
 
65
%
 
71
%
Risk-free interest rate
0.11
%
 
0.32
%
 
0.11% - 0.20%
 
0.32%-0.43%

Expected dividend yield
%
 
%
 
%
 
%
Weighted average grant date fair value
$
2.36

 
$
1.39

 
$
2.39

 
$
1.38

As of October 30, 2011, there was approximately $4.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants, which will be recognized over the remaining weighted average vesting period of approximately 2.72 years.
As of October 30, 2011, the Company had $4.8 million of total unrecognized compensation expense, net of estimated forfeitures, related to the ESPP, which will be recognized over the remaining weighted average vesting period of approximately 1.13 years. Cash received from the purchase of shares under the ESPP was $2.7 million and $1.4 million for the six months ended October 30, 2011 and October 31, 2010, respectively.
Restricted Stock
Restricted stock was granted to employees at par value under the Company’s stock incentive plans and performance plans, or assumed in connection with an acquisition. In general, restricted stock vest over two to four years and are subject to the employees’ continuing service to the Company.
The cost of restricted stock awards is determined using the fair value of the Company’s common stock on the date of the grant, and compensation expense is recognized over the vesting period, which is generally two to four years.
As of October 30, 2011, the Company had $6.0 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to restricted stock awards, which will be recognized over the remaining weighted average vesting period of approximately 1.91 years.
Note 15.    Income Taxes
The Company estimates its annual effective tax rate at the end of each fiscal quarter. The Company's estimate takes into account estimations of annual pre-tax income, the geographic mix of pre-tax income and the Company's interpretations of tax laws. The following table presents the provision for income taxes and the effective tax rates.
 
Three months ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
Income (loss) before income taxes
$
3,391

 
$
(2,807
)
 
$
3,710

 
$
(5,734
)
Benefit from (provision for) income taxes
(403
)
 
93

 
(823
)
 
(238
)
Effective tax rate
11.9
%
 
3.3
%
 
22.2
%
 
4.2
%
The provision (benefit) for income taxes was $0.4 million and $(0.1) million for the three months ended October 30, 2011 and October 31, 2010, respectively, and $0.8 million and $0.2 million for the six months ended October 30, 2011 and October 31, 2010, respectively. The effective tax rates were 11.9% and 3.3% for the three months ended October 30, 2011 and October 31, 2010, respectively,and 22.2% and 4.2% for the six months ended October 30, 2011 and October 31, 2010, respectively. Overall, the tax provision for the three and six months ended October 30, 2011 is due to higher foreign withholding tax payments and less favorable return-to-provision adjustments in the foreign countries than the three and six month periods ended October 31, 2010. Several foreign countries had favorable return-to-provision adjustments resulting in an overall tax benefit of $(0.1) million and tax provision of $0.2 million for the three and six months ended October 31, 2010. In addition, the Company is in a full valuation

15


allowance position in the U.S., thus the Company does not receive any tax benefit from making these foreign withholding tax payments.
The fluctuation in the effective tax rate is primarily driven by taxes on earnings from the Company's foreign subsidiaries. The Company's foreign subsidiaries are generally profitable due to the cost plus arrangements with the U.S. parent entity, thus taxable income is forecasted to be incurred for the Company's foreign operations regardless of consolidated results. The level of taxes on foreign earnings, combined with the change in the Company's consolidated operating results from losses for the three and six months ended October 31, 2010 ($2.8 million and $5.7 million, respectively) to profits for the three and six months ended October 30, 2011 ($3.4 million and $3.7 million, respectively) drove the increase in the effective tax rate.
The Company’s fiscal 2012 effective tax rate for the three months and six months ended October 30, 2011 differs from the combined federal and state statutory rate primarily due to changes in the Company's U.S. valuation allowance, state taxes, foreign income taxed at other than U.S. rates, stock compensation expense, research and development credits and foreign withholding taxes.
Note 16.    Segment Information
The Company reports segment information using the “management approach.” Under this approach, operating segments are identified in substantially the same manner as they are reported internally and used by the Company’s chief operating decision maker (“CODM”) for purposes of evaluating performance and allocating resources. Based on this approach, the Company has one reportable segment as the CODM reviews financial information on a basis consistent with that presented in the consolidated financial statements.
Revenue from North America, Europe, Japan and the Asia-Pacific region, which includes India, South Korea, Taiwan, Hong Kong and the People’s Republic of China, was as follows (in thousands, except for percentages shown):
 
Three Months Ended
 
Six Months Ended
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
North America*
$
26,553

 
$
20,878

 
$
49,860

 
$
38,795

Europe
5,274

 
3,805

 
10,074

 
5,788

Japan
2,183

 
2,617

 
4,179

 
8,436

Asia-Pacific (excluding Japan)
4,273

 
6,626

 
9,476

 
13,463

 
$
38,283

 
$
33,926

 
$
73,589

 
$
66,482

 
 
 
 
 
 
 
 
 
October 30,
2011
 
October 31,
2010
 
October 30,
2011
 
October 31,
2010
North America*
69
%
 
62
%
 
68
%
 
58
%
Europe
14
%
 
11
%
 
13
%
 
9
%
Japan
6
%
 
8
%
 
6
%
 
13
%
Asia-Pacific (excluding Japan)
11
%
 
19
%
 
13
%
 
20
%
 
100
%
 
100
%
 
100
%
 
100
%
*
Substantially all of the Company’s North America revenue is related to the United States for all periods presented.
For the three months ended October 30, 2011 and October 31, 2010, the Company had one customer that represented 13% and 15% of total revenue, respectively. For the six months ended October 30, 2011 and October 31, 2010, no customer represented 10% or more of total revenue. As of October 30, 2011, allowance for doubtful accounts was $0.2 million.

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Note 17.    Related Party Transactions
The Company leases a facility, which is used as its data center, from one of its customers. The lease expires in fiscal 2014.
During the three and six months ended October 30, 2011, the Company recorded $0.2 million and $0.5 million of rent expense and recognized $0.7 million and $1.7 million from the sale of software licenses to this customer.
During the three and six months ended October 31, 2010, the Company recorded $0.2 million and $0.5 million of rent expense and recognized $1.7 million and $3.3 million from the sale of software licenses to this customer.
A member of the Company's Board of Directors during the first quarter of fiscal 2012 also serves as a Board member for a customer of Magma. Magma recognized $0.2 million in revenue during the first quarter of fiscal 2012 from the sale of software licenses to this customer.
A member of the Company's Board of Directors during the second quarter of fiscal 2012 also serves as a senior executive for a customer of Magma. Magma recognized $0.1 million in revenue during the second quarter of fiscal 2012 from the sale of software licenses to this customer.
Note 18.     Subsequent Events
Pending Merger With Synopsys
On November 30, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Synopsys and Lotus Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Synopsys (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Synopsys (the “Merger”).
Pursuant to the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of the Company's common stock, other than treasury shares, shares held by Synopsys, Merger Sub or any wholly owned subsidiary of Synopsys or the Company and shares held by stockholders who perfect their appraisal rights, will be converted into the right to receive $7.35 in cash, without interest (the “Merger Consideration”). At the effective time of the Merger, certain equity awards held by employees of the Company will be converted into cash equal to the difference between the Merger Consideration and the exercise price, if any, of such awards, while other equity awards held by employees of the Company will be assumed by Synopsys and converted into equity awards of Synopsys on substantially equivalent terms.
The Merger Agreement also includes customary termination rights for both the Company and Synopsys. Upon termination of the Merger Agreement in certain specified circumstances, including a termination by the Company in connection with the acceptance of a superior offer pursuant to the terms and conditions set forth in the Merger Agreement, the Company will be required to pay Synopsys a termination fee equal to $18 million and, in certain other circumstances, $27 million. Upon termination of the Merger Agreement in certain circumstances related to a failure to obtain regulatory approval as specified in the Merger Agreement, Synopsys will be required to pay the Company a reverse termination fee equal to $30 million.
Consummation of the Merger is subject to certain conditions to closing, including, among other things, (i) the affirmative vote of the holders of a majority of the outstanding shares of the Company's common stock in favor of the adoption of the Merger Agreement, (ii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the absence of any order enjoining or prohibiting the consummation of the Merger or of any law making consummation of the Merger illegal, (iv) the absence of any legal proceeding challenging or seeking to prohibit consummation of the Merger, (v) subject to certain materiality exceptions, the accuracy of the Company's representations and warranties in the Merger Agreement, (vi) the performance in all material respects of the Company's covenants in the Merger Agreement, and (vii) the absence of any material adverse effect with respect to the Company during the interim period between the execution of the Merger Agreement and consummation of the Merger. The Merger is not subject to a financing condition.
On December 5, 2011, the Company, the members of the Company's Board of Directors, Synopsys and Merger Sub, were named as defendants in a purported stockholder class action lawsuit that was filed in the Superior Court of the State of California, County of Santa Clara. The complaint alleges, among other things, that the Company's directors breached their fiduciary duties to the Company's stockholders in negotiating and entering into the Merger Agreement and by agreeing to sell the Company at an unfair price, pursuant to an unfair process and pursuant to unreasonable terms, and that the Company, Synopsys and Merger Sub aided and abetted the alleged breaches of fiduciary duties. The complaint seeks, among other things, to enjoin consummation of the Merger. At this stage, it is not possible to predict the outcome of this proceeding or its impact on the Company. The Company believes the allegations made in this complaint are without merit and intends to vigorously defend this action.
The Merger is expected to close in the first half of calendar year 2012.

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    
This Management's Discussion and Analysis of Financial Condition and Results of Operations section should be read in conjunction with our condensed consolidated financial statements and results appearing elsewhere in this Quarterly Report on Form 10-Q and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K, for the fiscal year ended May 1, 2011, as amended . Throughout this section, and elsewhere in this Form 10-Q, we make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can often identify these and other forward-looking statements by terms such as “becoming,” “may,” “will,” “should,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” the negative of such terms or other comparable terminology, or the use of future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. These forward-looking statements include, but are not limited to:
our expectations regarding our proposed merger transaction with Synopsys, including the expected closing date of the proposed merger
our belief that our current facilities are adequate to support our current and near-term operations
our expectations about future revenue , including the product sources of such future revenue, and our belief that revenue fluctuations are a result of timing of customer purchases of service
our expectation that we will attain a certain level of cash flow from license sales, maintenance agreements, consulting contracts, customer contracts, acquired workforce and acquired developed technologies and patents
our expectation that our sales cycle will lengthen
our expectation that we will generally continue to depend upon a relatively small number of customers for a substantial portion of our revenue
our belief that growth rates in the semiconductor market have began to recover
our expectation that we will retain future earnings, if any, to fund the development and growth of our business
our expectations concerning our backlog orders
our belief that we have sufficient capital resources to fund our anticipated operating and working capital requirements, capital investments and debt service
our expected capital expenditures during fiscal 2012 and their expected purposes, and our expected sources of such capital expenditures
our belief that our acquisitions will enable us to compete successfully in the EDA industry and our expectation that we will be able to make acquisitions in the future
our expectation that we will be able to continue to use earnout arrangements to consummate our acquisitions and our belief that these arrangements will not complicate integration efforts
Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, and we have based these expectations on our beliefs and assumptions, such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our forward-looking statements. These statements involve certain known and unknown risks and uncertainties. Factors that could cause or contribute to such differences include, but are not limited to, the risks discussed under the heading “Risk Factors” or included elsewhere in this Quarterly Report on Form 10-Q, and in our Annual Report on Form 10-K for the fiscal year ended May 1, 2011, as amended. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Quarterly Report on Form 10-Q to reflect actual results or future events or circumstances.
Overview
We provide electronic design automation (“EDA”) software products and related services. Our software enables chip designers to reduce the time it takes to design and produce complex integrated circuits used in the communications, computing, consumer electronics, networking and semiconductor industries. Our products are used in all major phases of the chip development cycle, from initial design through physical implementation. Our focus is on software used to design the most technologically advanced integrated circuits, specifically those with minimum feature sizes of 0.65 nanometers and smaller, including the newest 28-nanometer process node.
As an EDA software provider, we generate substantially all of our revenue from the semiconductor and electronics industries.

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Our customers typically fund purchases of our software and services out of their research and development (“R&D”) budgets. As a result, our revenue is heavily influenced by our customers’ long-term business outlook and willingness to invest in new chip designs.
The semiconductor industry is highly volatile and cost-sensitive. Our customers focus on controlling costs and reducing risk, lowering R&D expenditures, decreasing design starts, purchasing from fewer suppliers, and requiring more favorable pricing and payment terms from suppliers. In addition, intense competition among suppliers of EDA products has resulted in pricing pressure on EDA products.
To support our customers, we have focused on providing technologically advanced products to address each step in the integrated circuit design process, as well as integrating these products into broad platforms, and expanding our product offerings. Our goal is to be the EDA technology supplier of choice for our customers as they pursue longer-term, broader and more flexible relationships with fewer suppliers.
During the second quarter of fiscal 2012, we recognized revenue of $38.3 million, an increase of 13% from the second quarter of fiscal 2011. License revenue for each of the quarters ended October 30, 2011 and October 31, 2010 accounted for approximately 83% and 79% of total revenue, respectively.
Pending Merger with Synopsys
On November 30, 2011, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Synopsys, Inc. (“Synopsys”) and Lotus Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Synopsys (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into us, and we will continue as the surviving corporation and a wholly owned subsidiary of Synopsys (the “Merger”).
Pursuant to the terms of the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our common stock, other than treasury shares, shares held by Synopsys, Merger Sub or any wholly owned subsidiary of Synopsys or ours and shares held by stockholders who perfect their appraisal rights, will be converted into the right to receive $7.35 in cash, without interest (the “Merger Consideration”). At the effective time of the Merger, certain equity awards held by our employees will be converted into cash equal to the difference between the Merger Consideration and the exercise price, if any, of such awards, while other equity awards held by our employees will be assumed by Synopsys and converted into equity awards of Synopsys on substantially equivalent terms.
The Merger Agreement also includes customary termination rights for both us and Synopsys. Upon termination of the Merger Agreement in certain specified circumstances, including a termination by us in connection with the acceptance of a superior offer pursuant to the terms and conditions set forth in the Merger Agreement, we will be required to pay Synopsys a termination fee equal to $18 million and, in certain other circumstances, $27 million. Upon termination of the Merger Agreement in certain circumstances related to a failure to obtain regulatory approval as specified in the Merger Agreement, Synopsys will be required to pay us a reverse termination fee equal to $30 million.
Consummation of the Merger is subject to certain conditions to closing, including, among other things, (i) the affirmative vote of the holders of a majority of the outstanding shares of our common stock in favor of the adoption of the Merger Agreement, (ii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) the absence of any order enjoining or prohibiting the consummation of the Merger or of any law making consummation of the Merger illegal, (iv) the absence of any legal proceeding challenging or seeking to prohibit consummation of the Merger, (v) subject to certain materiality exceptions, the accuracy of our representations and warranties in the Merger Agreement, (vi) the performance in all material respects of our covenants in the Merger Agreement, and (vii) the absence of any material adverse effect with respect to us during the interim period between the execution of the Merger Agreement and consummation of the Merger. The Merger is not subject to a financing condition.
The Merger is expected to close in the first half of calendar year 2012.
Global Markets
Recent market and economic conditions have been challenging, with tighter credit conditions and continued slow global economic growth through fiscal 2011 and the first half of fiscal 2012. Continued concerns about the global financial and banking system, systemic impact of inflation (or deflation), energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased market volatility and diminished expectations for the global economy generally.
As a result of these market conditions, the availability and cost of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the financial markets has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. If these market conditions decline, they may limit our or our customer's ability to access the capital markets to meet liquidity needs, resulting in an adverse effect on

19


our financial condition and results of operations. However, growth rates in the semiconductor industry have recently began to recover.
Critical Accounting Policies and Estimates
In preparing our condensed consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the most significant potential impact on our financial statements. For that reason and due to the estimation processes involved in each, we consider these to be our critical accounting policies.
Revenue recognition
We recognize revenue on software arrangements involving multiple elements (such as software products, upgrades, enhancements, maintenance, installation and training) to be allocated to each element based on the relative fair values of the elements. The fair value of an element is based on evidence that is specific to us. If evidence of fair value does not exist for each element of a license arrangement and maintenance is the only undelivered element, then all revenue for the license arrangement is recognized over the term of the agreement. If evidence of fair value does exist for the elements that have not been delivered, but does not exist for one or more delivered elements, then revenue is recognized using the residual method, under which recognition of revenue for the undelivered elements is deferred and the residual license fee is immediately recognized as revenue for the elements delivered.
Our revenue recognition policy is detailed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K, for the fiscal year ended May 1, 2011, as amended. Management has made significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products (referred to as an “arrangement” in the accounting literature), we must evaluate whether our fee is “fixed or determinable” and assess whether “collectability is probable.” These judgments are discussed below.
The fee is fixed or determinable. With respect to each arrangement, we must make a judgment as to whether the arrangement fee is fixed or determinable. If the fee is fixed or determinable, then revenue is recognized upon delivery of the software (assuming other revenue recognition criteria are met). If the fee is not fixed or determinable, then the revenue is recognized when customer installments are due and payable.
In order for an arrangement to be considered to have fixed or determinable fees, 100% of the license, services and initial post contract support fee is to be paid within one year or less from the order date. We have a history of collecting fees on such arrangements according to contractual terms. Arrangements with payment terms extending beyond twelve months are considered not to be fixed or determinable.
Collectability is probable. In order to recognize revenue, we must make a judgment about the collectability of the arrangement fee. Our judgment of the collectability is applied on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers for which there is a history of successful collection. New customers are subjected to a credit review process, which evaluates the customers’ financial positions and ability to pay. If it is determined from the outset of an arrangement that collectability is not probable based upon our credit review process, revenue is recognized on a cash receipts basis (as each payment is collected).
Licenses and services revenue
We derive licenses revenue primarily from licenses of our design and implementation software and, to a lesser extent, from licenses of our analysis and verification products. We license our products under time-based and perpetual licenses whereby license revenue is recognized after the execution of a license agreement and the delivery of the product to the customer, provided that there are no uncertainties surrounding the product acceptance, fees are fixed or determinable, collection is probable and there are no remaining obligations other than maintenance.
For perpetual licenses and time-based license arrangements, where maintenance is included for the first period of the license term, with maintenance thereafter renewable by the customer at the substantive rates stated in their agreements with us, the stated rate for maintenance renewal is vendor-specific objective evidence (“VSOE”) of the fair value of maintenance in these arrangements. For these arrangements, license revenue is recognized using the residual method in the period in which the license agreement is executed assuming all other revenue recognition criteria are met. Where an arrangement involves extended payment terms, revenue recognized using the residual method is limited to amounts due and payable.
We provide design methodology assistance and specialized services relating to generalized turnkey design services. We have an established VSOE of fair value for consulting and training services. Therefore, revenue from such services is recognized when such services are performed. Our consulting services generally are not essential to the functionality of the software. Our software products are fully functional upon delivery and implementation does not require any significant modification or alteration. Services to our customers often include assistance with product adoption and integration and specialized design methodology assistance.

20


Customers typically purchase these professional services to facilitate the adoption of our 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. We generally recognize revenue from consulting services as the services are performed.
For transactions that include maintenance for the entire license term, we have no VSOE of fair value of maintenance. Therefore, we recognize license revenue ratably over the maintenance period. If an arrangement involves extended payment terms—that is, where payment for less than 100% of the arrangement fee is due within one year of the contract date—we recognize revenue to the extent of the lesser of the amount due and payable or the ratable portion. Where consulting and training services are included in arrangements that include time-based licenses and post contract support (“PCS”) where VSOE of PCS has not been established, the Company recognizes the entire arrangement fee ratably over the PCS service period, beginning with the delivery of the software, provided that all other revenue recognition criteria are met. We allocate these arrangements to licenses and services revenue based upon established VSOE of services revenue in the condensed consolidated statements of operations.
If we were to change any of these assumptions or judgments, it could cause a material increase or decrease in the amount of revenue that we report in a particular period. Amounts invoiced relating to arrangements where revenue cannot be recognized are reflected on our balance sheet as deferred revenue and recognized over time as the applicable revenue recognition criteria are satisfied.
Services revenue
We derive services revenue primarily from consulting and training for our software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized on a straight-line basis over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are performed or completed. Our consulting and training services are generally not essential to the functionality of the software. Our products are fully functional upon delivery of the product. Additional factors considered in determining whether the revenue should be accounted for separately include, but are not limited to: degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on our ability to recognize the software license fee.
Change in Revenue Reporting
Beginning with the first quarter of fiscal 2012, we reported revenue and cost of revenue in the condensed consolidated statements of operations in two categories: licenses revenue and services revenue. Previously, revenue and cost of revenue were reported in three categories: licenses, bundled licenses and services, and services. We concluded that the results of the bundled licenses and services category of revenue do not indicate a material trend in the historical or future performance of our operations. Bundled licenses and services revenue and cost of revenue are divided into their component parts and included with either licenses or services. We allocated the established VSOE of services revenue included in bundled licenses revenue to services revenue in the condensed consolidated statement of operations. Presentation of prior period revenue and cost of revenue has been adjusted to conform to the current period.
This change for financial reporting purposes conforms to the presentation of revenue and cost of revenue for management reporting and analysis purposes in our Management's Discussion and Analysis of Financial Conditions and Results of Operations since the third quarter of fiscal 2009. Bundled licenses and services revenue was presented as a category of revenue due to our revenue recognition accounting policy. We offer various contractual terms to our customers in designing license agreements to accommodate customer preferences, which are unrelated to product performance and service requirements, order volume, or pricing. The contractual terms that result in the recognition of bundled licenses and services revenue are subject to customer preferences and have historically been inconsistently elected by customers. Moreover, revenue from existing long-term contracts frequently shifts between revenue categories, with no change in the aggregate revenues recognized from such contracts. Because customers can choose to purchase the same products as either bundled or unbundled, under the former presentation, customer choices in any quarter can create the appearance of revenue volatility that does not reflect the underlying substance. We believe that separating the bundled contracts into their respective components of licenses and services more clearly reflects the results of revenues by removing the distorting effects of changing customer preferences. We also noted the former presentation and disclosure was inconsistent with industry practice of our main competitors, which inhibits comparability, relevance and usefulness to users of the financial statements for purposes of making investment decisions.
Stock-based compensation
Stock-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as expense, net of estimated forfeitures, over the vesting period of the award.
Determining the fair value of stock-based awards at the grant date requires the input of various highly subjective assumptions, including expected future stock price volatility, expected term of instruments and expected forfeiture rates. We established the

21


expected term for employee options and awards, as well as forfeiture rates, based on the historical settlement experience, while giving consideration to vesting schedules and to options that have estimated life cycles less than the contractual terms. Assumptions for option exercises and pre-vesting terminations of options were stratified for employee groups with sufficiently distinct behavior patterns. For fiscal 2011, expected future stock price volatility was developed based on the average of our historical daily stock price volatility and average implied volatility. For fiscal 2012, expected future stock price volatility was developed based on the average of our historical daily stock price volatility. Due to significant changes in our capital structure during fiscal 2011 and the lack of comparable traded option activity, management believes using historical daily stock price volatility exclusively for fiscal 2012 is a better basis for estimating future stock price volatility. These input factors are subjective and are determined using management’s judgment. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected.
Unbilled accounts receivable
Unbilled accounts receivable represents revenue that has been recognized in advance of being invoiced to the customer. In all cases, the revenue and unbilled receivables are for contracts that are non-cancelable, in which there are no contingencies and where the customer has taken delivery of both the software and the encryption key required to operate the software. We typically generate invoices 45 days in advance of contractual due dates, and we invoice the entire amount of the unbilled accounts receivable within one year from the contract inception.
Allowances for doubtful accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customer’s expected ability to pay and our collection history with each customer. We review significant invoices that are past due to determine if an allowance is appropriate using the factors described above. We also monitor our accounts receivable for concentration in any one customer, industry or geographic region.
The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional allowances in the future. If actual losses are significantly greater than the allowance we have established, that would increase our sales and marketing expenses and reported net loss. Conversely, if actual credit losses are significantly less than our allowance, this would decrease our sales and marketing expenses and our reported net income would increase.
As of October 30, 2011, one customer accounted for more than 10% of total receivables. We had an allowance of $0.2 million for doubtful accounts at October 30, 2011.
Accounting for asset purchases and business combinations
We are required to allocate the purchase price of acquired assets and business combinations to the tangible and intangible assets acquired, liabilities assumed, and in-process research and development based on their estimated fair values. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible assets.
Critical estimates in valuing certain of the intangible assets include, but are not limited to, future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts, acquired workforce and acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.
Other estimates associated with the accounting for business combinations may change as additional information becomes available regarding the assets acquired and liabilities assumed resulting in changes in the purchase price allocation.
Goodwill impairment
We test goodwill for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of the reporting units. We have determined that we have one reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for the reporting units. Any impairment loss recorded in the future could have a material adverse impact on our financial condition and results of operations.
We use a two-step approach to determining whether and by how much goodwill has been impaired. The first step requires

22


a comparison of the fair value of the Company (single reporting unit) to its net book value. If the fair value is greater, then no impairment is deemed to have occurred. If the fair value is less, then the second step must be performed to determine the amount, if any, of actual impairment. To determine the fair value, our review process includes the income method and is based on a discounted future cash flow approach that uses estimates including the following for the reporting unit: revenue, based on assumed market growth rates and its assumed market share; estimated costs; and appropriate discount rates based on the particular business’s weighted average cost of capital. Our estimate of market segment growth, market segment share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we use to manage the underlying business. Our business consists of both established and emerging technologies and our forecasts for emerging technologies are based upon internal estimates and external sources rather than historical information. We also considered our market capitalization on the dates of the Company’s impairment tests in determining the fair value of the business.
During fiscal 2011, we conducted our annual goodwill impairment test at December 31, 2010 using the market approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices and the number of shares outstanding of our common stock. At December 31, 2010, we determined that the fair value of the Company was greater than the net book value of the net assets of the reporting unit including goodwill and therefore concluded there was no impairment of goodwill.
During the six months ended October 30, 2011, there were no triggering events that would indicate an impairment and cause us to conduct an impairment test.
Valuation of intangibles and long-lived assets
Our intangible assets include acquired intangibles, excluding goodwill. Acquired intangibles with definite lives are amortized on a straight-line basis over the remaining estimated economic life of the underlying products and technologies (original lives assigned are one to six years). For assets to be held and used, we initiate our review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset exceeds its fair value. Based on our review, as of October 30, 2011, no impairment is indicated.
Income taxes
Significant judgment is required in determining our provision for income taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax outcome is uncertain. The amount of income taxes we pay could be subject to audits by federal, state, and foreign tax authorities, which could result in proposed assessments. Although we believe that our estimates are reasonable, no assurance can be given that the final outcome of these tax matters will not be different from what was reflected in our historical income tax provisions.
Deferred tax assets and liabilities result primarily from temporary differences between book and tax valuation of assets and liabilities, as well as federal and state net operating loss and credit carryforwards. We assess the likelihood that our net deferred tax assets will be recovered from future taxable income and, to the extent we believe that the recovery is not likely, we establish a valuation allowance. We consider all available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent fiscal years, future taxable income, and ongoing prudent and feasible tax planning strategies, in assessing the amount of the valuation allowance.
As of October 30, 2011, we believe it is more likely than not, that all or some portion of the deferred tax assets will not be realized; and accordingly, a valuation allowance against our U.S. net deferred tax assets is required. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. Future reversals or increases to our valuation allowance could have a significant impact on our future earnings.
Strategic investments in privately-held companies
Our strategic equity investments consist of preferred stock that is convertible into common stock of two privately-held companies. The carrying value of our portfolio of strategic equity investments totaled $0.5 million at October 30, 2011. Our ability to recover our investments in private, non-marketable equity securities and to earn a return on these investments is primarily dependent on how successfully these companies are able to execute on their business plans and how well their products are accepted, as well as their ability to obtain additional capital funding to continue operations.
Under our accounting policy, the carrying value of a non-marketable investment is the amount paid for the investment unless it has been determined to be other than temporarily impaired, in which case we write the investment down to its estimated fair value. For equity investments where our ownership interest is between 20% to 50%, or where we can exercise significant influence on the investee’s operating or financial decisions, we record our share of net equity income (loss) of the investee based on our proportionate ownership.
We review all of our investments periodically for impairment; however, for non-marketable equity securities, the fair value

23


analysis requires significant judgment. This analysis includes assessment of each investee’s financial condition, the business outlook for its products and technology, its projected results and cash flows, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by us or others. If an investee obtains additional funding at a valuation lower than our carrying amount, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, such as when we hold contractual rights that give us a preference over the rights of other investors. As the equity markets have experienced volatility over the past few years, we have experienced substantial impairments in our portfolio of non-marketable equity securities. If equity market conditions do not improve, as companies within our portfolio attempt to raise additional funds, the funds may not be available to them, or they may receive lower valuations, with more onerous investment terms than in previous financings, and the investments will likely become impaired. However, we are not able to determine at the present time which specific investments are likely to be impaired in the future, or the extent or timing of individual impairments. We recorded impairment charges related to these non-marketable equity investments of $12,000 and $47,000 for the three and six months ended October 30, 2011, respectively. Similarly, we recorded impairment charges related to these non-marketable equity investments of $31,000 and $0.1 million for the three and six months ended October 31, 2010, respectively for our proportionate share in the net losses of the investee companies.
The investments are included in other long-term assets in the consolidated balance sheets. The carrying value of the Company’s strategic investments was as follows (in thousands):
 
October 30,
2011
 
May 1,
2011
Non-Marketable Securities - Application of Equity Method
$
484

 
$
531

Total
$
484

 
$
531

During the fourth quarter of fiscal 2010, Synopsys, purchased 100% of the outstanding stock of Zerosoft, Inc., for $24.0 million in cash and future contingent cash payments. Our 35% ownership interest in Zerosoft, Inc. at the time of the sale resulted in $4.7 million in cash at closing and $4.3 million in contingent proceeds. The contingent proceeds consisted of a holdback amount equal to 10% of the initial consideration to be held in escrow and released for payment 15 months from the date of the agreement to secure the indemnification obligations of the sellers, and earnout consideration based upon the achievement of certain annual product performance improvement milestones for the three years subsequent to the sale agreement. The proceeds (net of expenses) of $4.6 million offset against the net book value of the investment of $1.4 million on the date of sale of the investment resulted in a net gain of $3.2 million, which was recorded in the statement of operations in other income. The holdback amount and earnout consideration are gain contingencies each representing incremental income and will be recognized if and when all contingencies are resolved. For the six months ended October 30, 2011, we did not receive any earnout consideration.
During the first quarter of fiscal 2012, we received contingent proceeds of $0.5 million that were held in escrow. The proceeds have been recorded in other income in the condensed consolidated statement of operations.
Results of Operations
Revenue
Revenue is comprised of licenses and services revenue. Licenses revenue consists of fees for time-based or perpetual licenses of our software products. Services revenue consists of fees for services, such as customer training, consulting and PCS associated with licenses. We recognize revenue based on the specific terms and conditions of the license contracts with our customers for our products and services as described above under the caption “Critical Accounting Policies and Estimates.”
Licenses revenue
Licenses revenue is divided into the following categories:
Ratable
Due & Payable
Up-Front
Cash Receipts
We use these classifications of revenue to provide greater insight into the reporting and monitoring of trends in the components of our revenue and to assist us in managing our business. The characterization of an individual contract may change over time. For example, a contract originally characterized as Ratable may be redefined as Cash Receipts if that customer has difficulty in making payments in a timely fashion. In cases where a contract has been re-characterized for management’s discussion and analysis purposes, prior periods are not restated to reflect that change.
Ratable. For time-based licenses that include maintenance or services where VSOE is not established, we recognize license

24


revenue ratably over the contract term, or as customer payments become due and payable, if less. In our statements of operations the revenue for these arrangements are allocated to their component parts, and included in either license or service revenue based on arrangements where VSOE for maintenance and services has been established. We refer to these licenses generally as “Ratable” and we generally refer to all time-based licenses recognized on a ratable basis as “Long-Term,” independent of the actual length of term of the license.
Due & Payable. For time-based licenses that include maintenance or services where VSOE is established and the payment terms extend greater than one year from the arrangement effective date, we recognize license revenue on a due and payable basis. For management reporting and analysis purposes, we refer to this type of license generally as “Due & Payable.”
Up-Front. For time-based and perpetual licenses that include maintenance or services where VSOE is established, we recognize license revenue upon shipment if the payment terms require the customer to pay 100% of the license fee and the initial period of PCS is within one year from the agreement date. In all of these cases, the contracts are non-cancelable, and the customer has taken delivery of both the software and the encryption key required to operate the software. For management reporting and analysis purposes, we refer to this type of license generally as “Up-Front,” where the license is either perpetual or time-based.
Cash Receipts. We recognize revenue from customers who have not met our predetermined credit criteria as we receive cash payments from these customers to the extent that revenue has otherwise been earned. For management reporting and analysis purposes, we refer to this type of license revenue as “Cash Receipts.”
Our licenses revenue in any given quarter depends upon the mix and volume of perpetual or short-term licenses ordered during the quarter and the amount of long-term ratable, due & payable, and cash receipts license revenue recognized during the quarter. In general, we refer to license revenue recognized from perpetual or time-based licenses during the current period as “Up-Front” revenue for management reporting and analysis purposes. All other types of revenue are generally referred to as revenue from backlog, such as licenses revenue recognized during the current period from perpetual or time-based licenses from contracts entered into in prior periods. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve a certain level of orders and a certain mix of short-term licenses. The precise mix of orders fluctuates substantially from period to period and affects the revenue we recognize in the period. If we achieve our target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we have more-than-expected long-term licenses) or may exceed them (if we have more-than-expected short-term or perpetual licenses). If we achieve the target license mix but the overall level of orders is below the target level, then we may not meet our revenue targets as described in the risk factors in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Services revenue
Services revenue is primarily from consulting and training for our software products and from maintenance fees for our products. Most of our license agreements include maintenance, generally for a one-year period, renewable annually. Services revenue from maintenance arrangements is recognized ratably over the maintenance term. Because we have VSOE of fair value for consulting and training services, revenue is recognized as these services are performed or completed.
Revenue, cost of revenue and gross profit
The table below sets forth the fluctuations in revenue, cost of revenue and gross profit data by category as defined for management reporting and analysis purposes for the three and six months ended October 30, 2011 and October 31, 2010 (in thousands, except for percentage data):

25


Three Months Ended:
October 30,
2011
 
% of
Revenue
 
October 31,
2010
 
% of
Revenue
 
Dollar
Change
 
% Change
Revenue
 
 
 
 
 
 
 
 
 
 
 
Licenses revenue
 
 
 
 
 
 
 
 
 
 
 
Ratable
$
5,696

 
15
%
 
$
4,612

 
14
%
 
$
1,084

 
24
 %
Due & Payable
6,003

 
16
%
 
16,349

 
48
%
 
(10,346
)
 
(63
)%
Up-Front*
18,379

 
48
%
 
4,332

 
13
%
 
14,047

 
324
 %
Cash Receipts
1,473

 
4
%
 
1,610

 
5
%
 
(137
)
 
(9
)%
Total Licenses revenue
31,551

 
83
%
 
26,903

 
79
%
 
4,648

 
17
 %
Services revenue
6,732

 
17
%
 
7,023

 
21
%
 
(291
)
 
(4
)%
Total Revenue
38,283

 
100
%
 
33,926

 
100
%
 
4,357

 
13
 %
Cost of Revenue
 
 
 
 
 
 
 
 
 
 
 
License
542

 
1
%
 
998

 
3
%
 
(456
)
 
(46
)%
Services
4,011

 
10
%
 
4,065

 
12
%
 
(54
)
 
(1
)%
Total cost of sales
4,553

 
11
%
 
5,063

 
15
%
 
(510
)
 
(10
)%
Gross Profit
$
33,730

 
89
%
 
$
28,863

 
85
%
 
$
4,867

 
17
 %
Six Months Ended:
October 30, 2011
 
% of
Revenue
 
October 31, 2010
 
% of
Revenue
 
Dollar
Change
 
% Change
Revenue
 
 
 
 
 
 
 
 
 
 
 
Licenses revenue
 
 
 
 
 
 
 
 
 
 
 
Ratable
$
11,392

 
16
%
 
$
10,954

 
16
%
 
$
438

 
4
 %
Due & Payable
21,114

 
29
%
 
28,589

 
43
%
 
(7,475
)
 
(26
)%
Up-Front*
20,906

 
28
%
 
7,542

 
11
%
 
13,364

 
177
 %
Cash Receipts
4,696

 
6
%
 
4,157

 
7
%
 
539

 
13
 %
Total Licenses revenue
58,108

 
79
%
 
51,242

 
77
%
 
6,866

 
13
 %
Services revenue
15,481

 
21
%
 
15,240

 
23
%
 
241

 
2
 %
Total Revenue
73,589

 
100
%
 
66,482

 
100
%
 
7,107

 
11
 %
Cost of Revenue
 
 
 
 
 
 
 
 
 
 
 
License
1,161

 
2
%
 
1,934

 
3
%
 
(773
)
 
(40
)%
Services
8,011

 
11
%
 
7,871

 
12
%
 
140

 
2
 %
Total cost of sales
9,172

 
13
%
 
9,805

 
15
%
 
(633
)
 
(6
)%
Gross Profit
$
64,417

 
87
%
 
$
56,677

 
85
%
 
$
7,740

 
14
 %
*
Includes $8.8 million, or 23%, of revenue from new contracts in the second fiscal quarter of fiscal 2012 and $9.6 million, or 13%, of revenue from contracts signed in the second quarter.
We market our products and related services to customers in four geographic regions: North America (Domestic), Europe (including Europe, the Middle East and Africa), Japan, and Asia-Pacific (including India, South Korea, Taiwan, Hong Kong and the People’s Republic of China). Internationally, we market our products and services primarily through our subsidiaries and various distributors. Revenue is attributed to geographic areas based on the country in which the customer is domiciled. The table below sets forth geographic distribution of revenue data for the three and six months ended October 30, 2011 and October 31, 2010 (in thousands, except for percentage data):

26


Three Months Ended:
October 30,
2011
 
% of
Revenue
 
October 31, 2010
 
% of
Revenue
 
Dollar Change
 
%
Change
North America
$
26,553

 
69
%
 
$
20,878

 
62
%
 
$
5,675

 
27
 %
International:
 
 
 
 
 
 
 
 
 
 
 
Europe
5,274

 
14
%
 
3,805

 
10
%
 
1,469

 
39
 %
Japan
2,183

 
6
%
 
2,617

 
8
%
 
(434
)
 
(17
)%
Asia-Pacific (excluding Japan)
4,273

 
11
%
 
6,626

 
20
%
 
(2,353
)
 
(36
)%
Total international
11,730

 
31
%
 
13,048

 
38
%
 
(1,318
)
 
(10
)%
Total revenue
$
38,283

 
100
%
 
$
33,926

 
100
%
 
$
4,357

 
13
 %
Six Months Ended:
October 30, 2011
 
% of
Revenue
 
October 31, 2010
 
% of
Revenue
 
Dollar Change
 
%
Change
North America
$
49,860

 
68
%
 
$
38,795

 
58
%
 
$
11,065

 
29
 %
International:
 
 
 
 
 
 
 
 
 
 
 
Europe
10,074

 
13
%
 
5,788

 
9
%
 
4,286

 
74
 %
Japan
4,179

 
6
%
 
8,436

 
13
%
 
(4,257
)
 
(50
)%
Asia-Pacific (excluding Japan)
9,476

 
13
%
 
13,463

 
20
%
 
(3,987
)
 
(30
)%
Total international
23,729

 
32
%
 
27,687

 
42
%
 
(3,958
)
 
(14
)%
Total revenue
$
73,589

 
100
%
 
$
66,482

 
100
%
 
$
7,107

 
11
 %
Revenue
Revenue for the three and six months ended October 30, 2011 was $38.3 million and $73.6 million, respectively, an increase of 13% and 11% from each of the three and six months ended October 31, 2010, respectively.
Licenses revenue increased by 17% and 13% in the three and six months ended October 30, 2011 as compared to the three and six months ended October 31, 2010. The increase in licenses revenue was due to enhanced versions of several existing products gaining initial market acceptance, combined with some improvement in economic conditions in the semiconductor industry, which resulted in an increase in customer spending.
Ratable and Due & Payable revenue combined decreased by $9.3 million, or 44%, and $7.0 million or 18% for the three and six months ended October 30, 2011, respectively as compared to the three and six months ended October 31, 2010. The decrease as a percentage of total revenue is the result of the mix and volume of revenue from backlog from long-term Ratable and Due & Payable contracts recognized during the quarter compared to Up-Front revenue. The mix and volume of contracts is primarily driven by customer requirements.
Up-Front revenue increased $14.0 million, or 324%, and $13.4 million or 177% for the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. The increase as a percent of total revenue is the result of the mix and volume of Up-Front revenue recognized during the quarter compared to revenue from backlog from long-term Ratable and Due & Payable contracts. The mix and volume of Up-Front revenue is related to specific customer contracts and included $8.8 million, or 23%, of revenue from new contracts signed in the second fiscal quarter of 2012 and $9.6 million or 13%, of revenue from contracts signed in second fiscal quarter of 2012.
Cash Receipts revenue decreased by $0.1 million and increased by $0.5 million during the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. The fluctuation is due to cash received from customers earlier classified as cash receipts.
Services revenue decreased by $0.3 million and increased by $0.2 million for the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. We believe the fluctuations were a result of the timing of customer’s purchase of services.
North America revenue increased by $5.7 million or 27% and $11.1 million or 29% during the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. The increase in the domestic revenue is due to the improvement in economic conditions in the semiconductor industry which resulted in an increase in customer spending.
International revenue decreased by $1.3 million or 10% and $4.0 million or 14% during the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. The decrease in international revenue was mainly due to a $4.3 million decrease in the revenue from Japan during the three and six months ended October 30,

27


2011. The revenue from Japan decreased due to consolidations in the semi-conductor industry involving certain of our customers, which was a result of global competition and efforts to improve efficiency and eliminate overlap. Revenue from the Asia-Pacific region decreased during the three and six months ended October 30, 2011 as compared to the three and six months ended October 31, 2010 due to the timing of revenue recognition.
One customer accounted for 10% or more of total revenue for each of the fiscal quarters ended October 30, 2011 and October 31, 2010.
Cost of Revenue
Cost of licenses revenue primarily consists of amortization of acquired developed technology and other intangible assets that are fixed in nature, variable expenses such as royalties, and allocated outside sales representative expenses.
Cost of licenses revenue decreased by $0.5 million, or 46% and $0.8 million, or 40% during the three and six months ended October 30, 2011, respectively, compared to the three and six months ended October 31, 2010, primarily due to the full amortization of significant intangible assets from prior acquisitions.
Cost of services revenue primarily consists of personnel and related costs to provide product support, training and consulting services. Cost of services revenue also includes stock-based compensation expenses and asset depreciation.
Cost of services revenue decreased by $0.1 million or 1% and increased by $0.1 million, or 2%, for the three and six months ended October 30, 2011, respectively, as compared to the three and six months ended October 31, 2010. The fluctuations were due to changes in consulting costs.
Operating expenses
The table below sets forth operating expense data for the three and six months ended October 30, 2011 and October 31, 2010 (in thousands, except for percentage data):
Three Months Ended:
October 30,
2011
 
% of
Revenue
 
October 31,
2010
 
% of
Revenue
 
Dollar
Change
 
%
Change
Operating Expenses
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
12,698

 
33
%
 
$
11,747

 
35
%
 
$
951

 
8
 %
Sales and marketing
11,481

 
30
%
 
11,319

 
33
%
 
162

 
1
 %
General and administrative
5,218

 
14
%
 
4,625

 
14
%
 
593

 
13
 %
Amortization of intangible assets
149

 
%
 
289

 
1
%
 
(140
)
 
(48
)%
Restructuring charges
520

 
1
%
 
182

 
1
%
 
338

 
186
 %
Total operating expenses
$
30,066

 
78
%
 
$
28,162

 
84
%
 
$
1,904

 
7
 %
Six Months Ended:
October 30, 2011
 
% of
Revenue
 
October 31, 2010
 
% of
Revenue
 
Dollar
Change
 
%
Change
Operating Expenses
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
25,483

 
35
%
 
$
24,006

 
36
%
 
$
1,477

 
6
 %
Sales and marketing
21,891

 
30
%
 
21,886

 
33
%
 
5

 
 %
General and administrative
11,389

 
15
%
 
9,315

 
14
%
 
2,074

 
22
 %
Amortization of intangible assets
351

 
%
 
545

 
1
%
 
(194
)
 
(36
)%
Restructuring charges
1,246

 
2
%
 
168

 
%
 
1,078

 
642
 %
Total operating expenses
$
60,360

 
82
%
 
$
55,920

 
84
%
 
$
4,440

 
8
 %
Research and development expense increased by $1.0 million, or 8%, in the three months ended October 30, 2011 as compared to the three months ended October 31, 2010. The increase was primarily due to an increase in payroll related expense of $1.1 million as a result of merit increases implemented at the beginning of fiscal 2012. The increase was also attributable to an increase of $0.2 million related to common expenses, such as information technology and facility related expenses. The increase was offset by a decrease in $0.3 million in consulting expenses.
Research and development expense increased by $1.5 million, or 6%, in the six months ended October 30, 2011 as compared to the six months ended October 31, 2010. The increase was primarily due to an increase in payroll related expense by $2.0 million as a result of merit increases implemented at the beginning of fiscal 2012. This increase was offset by a decrease of $0.3 million related to stock based compensation expenses and $0.2 million of consulting expenses.
Sales and marketing expense increased by $0.2 million, or 1%, in the three months ended October 30, 2011 as compared

28


to the three months ended October 31, 2010. The increase was due to an increase in payroll related expense of $0.7 million due to merit increases implemented at the beginning of fiscal 2012. The increase is also attributable to an increase in bad debt expense of $0.2 million. These increases were offset by a decrease in stock based compensation of $0.6 million and a decrease in travel and entertainment expenses of $0.1 million.
Sales and marketing expense was essentially flat in the six months ended October 30, 2011 as compared to the six months ended October 31, 2010. During the six months ended October 30, 2011, commission expense increased by $1.0 million, bad debt expense increased by $0.2 million, and payroll related costs increased by $0.3 million due to merit increases implemented at the beginning of fiscal 2012. These increases were offset by a decrease in stock based compensation of $0.7 million, a decrease in travel and entertainment expenses of $0.3 million, a decrease in common expenses such as information and technology expense of $0.2 million and a decrease in pre-sales engineer costs of $0.3 million.
General and administrative expense increased by $0.6 million, or 13%, in the three months ended October 30, 2011, as compared to three months ended October 31, 2010. The increase was mainly due to the increase of $0.2 million in payroll related expenses due to merit increases implemented at the beginning of fiscal 2012, an increase of $0.3 million in stock based compensation and an increase of $0.1 million in additional legal and administrative costs incurred due to an investigation conducted by the Audit Committee of the Board of Directors of whistleblower allegations related to business expense reimbursements, executive and other employee compensation, and restructuring costs. The investigation was concluded in the first quarter of fiscal 2012.
General and administrative expense increased by $2.1 million, or 22%, in the six months ended October 30, 2011, as compared to six months ended October 31, 2010. The increase was mainly due to the increase of $0.5 million in payroll related expenses due to merit increases implemented at the beginning of fiscal 2012, an increase of $0.1 million in stock based compensation and an increase of $1.7 million in additional legal and administrative costs incurred due to the Audit Committee investigation referenced above. The increase was offset by a decrease in consulting expenses of $0.2 million.
Amortization of intangible assets decreased by $0.1 million, or 49%, and $0.2 million or 36%, during the three and six months ended