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SYNOPSYS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q, and in particular the following discussion, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements can, in some cases, be identified by the use of terms such as "may," "will," "could," "would," "should," "anticipate," "expect," "intend," "believe," "estimate," "project" or "continue," the negatives of such terms, or other comparable terminology. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Without limiting the foregoing, forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements concerning the expected growth in the semiconductor industry, our positive business outlook, the ability of our prior acquisitions to drive revenue growth, the percent of revenue with which we expect to enter each quarter, our expectations with respect to organic and inorganic growth opportunities, our ability to make adjustments to our business as market conditions change, our ability to successfully execute our strategies, the sufficiency of our cash, cash equivalents and short-term investments and cash generated from operations, and our future liquidity requirements. These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those identified below in Part II, Item 1A. Risk Factors of this Form 10-Q. The information included herein is given as of the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC) and future events or circumstances could differ significantly from these forward-looking statements. Accordingly, we caution readers not to place undue reliance on these statements. Unless required by law, we undertake no obligation to update publicly any forward-looking statements. All subsequent written or oral forward-looking statements attributable to Synopsys or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and in other documents we file from time to time with the SEC that attempt to advise interested parties of the risks and factors that may affect our business. The following summary of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1. of this report and with our audited consolidated financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2010, as filed with the SEC on December 17, 2010 and amended on February 9, 2011. Fiscal Year End. Our fiscal year ends on the Saturday nearest to October 31. Our third quarter of fiscal 2011 ended on July 30, 2011. Fiscal 2011 and fiscal 2010 are both 52-week fiscal years. For presentation purposes, this Form 10-Q, including the unaudited condensed consolidated financial statements and accompanying notes, refers to the closest calendar month end. Overview Business Summary Synopsys is a world leader in providing technology solutions used to develop electronics and electronic systems. We supply the electronic design automation (EDA) software that engineers use to design, create prototypes for and test integrated circuits, also known as chips. We also supply software and hardware used to develop the systems that incorporate integrated circuits and the software that runs on those integrated circuits. Our intellectual property (IP) products are pre-designed circuits that engineers use as components of larger chip designs rather than redesigning those circuits themselves. To complement these product offerings, we provide technical services to support our solutions and we help our customers develop chips and electronic systems. Our customers are generally large semiconductor and electronics manufacturers. Our solutions help them overcome the challenge of developing increasingly advanced electronics products while reducing their design and manufacturing costs. While our products are an important part of our customers' development process, our customers' research and development budget and spending decisions may be impacted by their business outlook and their willingness to invest in new and increasingly complex chip designs. Despite recent global economic uncertainty, we have maintained profitability and positive cash flow on an annual basis in recent years. We achieved these results not only because of our solid execution, leading technology and strong customer relationships, but also because of our recurring revenue business model. Under this model, a substantial majority of our customers pay for their licenses over time and we typically recognize this recurring revenue over the life of the contract, which averages approximately three years. Recurring revenue generally represents more than 90% of our 21-------------------------------------------------------------------------------- Table of Contents total revenue. The revenue we recognize in a particular period generally results from selling efforts in prior periods rather than the current period. We typically enter each quarter with greater than 90% of our revenue for that particular quarter already committed from our customers, providing for stability and predictability of results. Due to our business model, decreases as well as increases in customer spending do not immediately affect our revenues in a significant way. The semiconductor industry has experienced moderate growth to date in 2011. However, our semiconductor customers remain cautious and focused on their costs due to the cyclical nature of the industry, the increasing complexity of product development and macroeconomic factors. The recent instability of global markets may create a more challenging environment for our customers to plan investment in research and development. Nevertheless, our business outlook is positive based on growth forecasts for the semiconductor industry and our strong financials, diligent expense management, and acquisition strategy. Through our recent acquisitions, we have enhanced our technology and expanded our product portfolio and our total addressable market, especially in IP and system-level solutions, which we believe will help drive revenue growth. We expect to explore both organic and inorganic growth opportunities, including acquiring companies or technology that can contribute to the strategic, operational and financial performance of our business. We will continue to monitor worldwide economic growth rates, the considerable volatility of current global markets and other macroeconomic factors and may make adjustments to our business in the event that the semiconductor industry is unable to maintain current spending levels for our solutions. We believe that the combination of our solid financials, leading technology and strong customer relationships will help us successfully execute our strategies. Financial Performance Summary for the Three Months Ended July 31, 2011 • We continued to derive more than 90% of our revenue from time-based licenses, maintenance and services. • Our total revenue of $386.8 million increased by $49.9 million, or 15%, from $336.9 million in the same period of fiscal 2010. The increase was attributable to our overall growth, including sales of products associated with our prior-year acquisitions, which resulted in increased time-based license revenue, upfront license revenue and professional services revenue. • Our cost of revenue and operating expenses increased compared to the same period in fiscal 2010 primarily due to increases in employee-related costs driven by increased headcount and other direct costs from our prior-year acquisitions. • Our net income of $52.1 million increased by $12.8 million, or 33%, from $39.3 million in the same period of fiscal 2010. The increase was primarily due to overall revenue growth and a lower effective tax rate in fiscal 2011. • Our net cash from operating activities of $367.3 million for the nine months ended July 31, 2011, an increase of $123.2 million, or 50%, from $244.1 million in the same period of fiscal 2010. This increase was primarily from increased customer collections due to our volume of contracts and the timing of billings to customers. Critical Accounting Policies and Estimates Our discussion and analysis of our financial results under the heading "Results of Operations" below are based on our unaudited condensed consolidated financial statements, which we have prepared in accordance with U.S. GAAP. In preparing these financial statements, we make assumptions, judgments and estimates that can affect the reported amounts of assets, liabilities, revenues and expenses and net income. On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances. Our actual results may differ from these estimates. The accounting policies that most frequently require us to make assumptions, judgments and estimates, and therefore are critical to understanding our results of operations, are: • Revenue recognition; • Valuation of stock compensation; • Valuation of intangible assets; and • Income taxes. We describe our revenue recognition policy below. Our remaining critical accounting policies and estimates are discussed in Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2010, filed with the SEC on December 17, 2010 and amended on February 9, 2011. 22-------------------------------------------------------------------------------- Table of Contents Revenue Recognition. Software license revenue consists of fees associated with the licensing of our software. Maintenance and service revenue consists of maintenance fees associated with perpetual and term licenses and professional services fees. Hardware revenue consists of Field Programmable Gate Array (FPGA) board-based products. With respect to software licenses, we utilize three license types: • Technology Subscription Licenses (TSLs). TSLs are time-based licenses for a finite term, and generally provide the customer limited rights to receive, or to exchange certain quantities of licensed software for, unspecified future technology. We bundle and do not charge separately for post-contract customer support (maintenance) for the term of the license. • Term licenses. Term licenses are also for a finite term, but do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually for the balance of the term. The annual maintenance fee is typically calculated as a percentage of the net license fee. • Perpetual licenses. Perpetual licenses continue as long as the customer renews maintenance plus an additional 20 years. Perpetual licenses do not provide the customer any rights to receive, or to exchange licensed software for, unspecified future technology. Customers purchase maintenance separately for the first year and may renew annually. For the three software license types, we recognize revenue as follows: • TSLs. We typically recognize revenue from TSL fees (which include bundled maintenance) ratably over the term of the license period, or as customer installments become due and payable, whichever is later. Revenue attributable to TSLs is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations. • Term licenses. We recognize revenue from term licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these term licenses is reported as "upfront license revenue" in the unaudited condensed consolidated statements of operations. For term licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer payments become due and payable. Such revenue is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations. • Perpetual licenses. We recognize revenue from perpetual licenses in full upon shipment of the software if payment terms require the customer to pay at least 75% of the license fee and 100% of the maintenance fee within one year from shipment and all other revenue recognition criteria are met. Revenue attributable to these perpetual licenses is reported as "upfront license revenue" in the unaudited condensed consolidated statements of operations. For perpetual licenses in which less than 75% of the license fee and 100% of the maintenance fee is payable within one year from shipment, we recognize revenue as customer installments become due and payable. Such revenue is reported as "time-based license revenue" in the unaudited condensed consolidated statements of operations. We also enter into arrangements in which portions of revenue are contingent upon the occurrence of uncertain future events, for example, royalty arrangements. We refer to this revenue as "contingent revenue." Contingent revenue is recognized if and when the applicable event occurs. It is reported as "time-based revenue" in the unaudited condensed consolidated statements of operations. Historically, these arrangements have not been material to our total revenue. We recognize revenue from hardware sales in full upon shipment if all other revenue recognition criteria are met. Revenue attributable to these hardware sales is reported as "upfront license revenue" in the unaudited condensed consolidated statements of operations. Hardware sales have not been material to our total revenue. We infrequently enter into multiple-element arrangements that contain both software and non-software deliverables such as hardware. On a prospective basis beginning in our first quarter of fiscal 2011, we apply recently issued accounting guidance for revenue arrangements with multiple deliverables for these contracts. The adoption of the new guidance did not have a material effect on our unaudited condensed consolidated financial statements, is not expected to have a material effect on subsequent periods and did not affect the accounting for contracts which do not contain non-software deliverables. The recent accounting guidance addresses whether to treat individual deliverables or groups of deliverables in a multiple-element arrangement as separate units of accounting and how to allocate the arrangement consideration to the separate units of accounting. The guidance also requires that arrangement consideration be allocated to software deliverables (as a group) and to non-software deliverables (individually) based on relative standalone selling prices and provides guidance for estimating standalone selling prices for purposes of allocating arrangement consideration. 23-------------------------------------------------------------------------------- Table of Contents We have determined that the software and non-software deliverables in our contracts are separate units of accounting. Prior to our first quarter of fiscal 2011, all deliverables in our contracts were considered one unit of accounting unless we had vendor-specific objective evidence (VSOE) of fair value for all undelivered elements. We now allocate arrangement consideration to separate units of accounting based on estimated standalone selling prices (ESP) because we do not have objective evidence of standalone selling prices. We estimate the standalone selling prices of our separate units of accounting considering both market conditions and our own specific conditions. For hardware deliverables, we determine ESP using cost plus a margin because we have consistent pricing practices and gross margins for these products. Determining the ESP for software deliverables requires significant judgment. We determine ESP for software deliverables after considering customer geographies, market demand and competition at the time of contract negotiation, gross margin objectives, existing portfolio pricing practices, contractually stated prices and prices for similar historical transactions. Under the recent accounting guidance we recognize revenue for our separate units of accounting when all revenue recognition criteria are met. Revenue allocated to hardware units of accounting is recognized upon delivery when all other revenue recognition criteria are met. Revenue allocated to software units of accounting is recognized according to the methods described above depending on the software license type (TSL, term license or perpetual license). We recognize revenue from maintenance fees ratably over the maintenance period to the extent cash has been received or fees become due and payable, and recognize revenue from professional services and training fees as such services are performed and accepted by the customer. Revenue attributable to maintenance, professional services and training is reported as "maintenance and service revenue" in the unaudited condensed consolidated statements of operations. We also enter into arrangements to deliver software products, either alone or together with other products or services that require significant modification, or customization of the software. We account for such arrangements using the percentage of completion method as we have the ability to make reasonably dependable estimates that relate to the extent of progress toward completion, contract revenues and costs. We measure the progress towards completion using the labor hours incurred to complete the project. Revenue attributable to these arrangements is reported as maintenance and service revenue in the unaudited condensed consolidated statements of operations. We determine the fair value of each element in multiple element software arrangements based on VSOE. We limit our assessment of VSOE of fair value for each element to the price charged when such element is sold separately. We have analyzed all of the elements included in our multiple-element software arrangements and have determined that we have sufficient VSOE to allocate revenue to the maintenance components of our perpetual and term license products and to professional services. Accordingly, assuming all other revenue recognition criteria are met, we recognize license revenue from perpetual and term licenses upon delivery using the residual method, recognize revenue from maintenance ratably over the maintenance term, and recognize revenue from professional services as services are performed or as milestones are met and accepted. We recognize revenue from TSLs ratably over the term of the license, assuming all other revenue recognition criteria are met, since there is not sufficient VSOE to allocate the TSL fee between license and maintenance services. We make significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products, we must evaluate whether: (1) persuasive evidence of an arrangement exists, (2) delivery of software or services has occurred, (3) the fee for such software or services is fixed or determinable, and (4) collectability of the full license or service fee is probable. All four of these criteria must be met in order for us to recognize revenue with respect to a particular arrangement. We apply these revenue recognition criteria as follows: • Persuasive Evidence of an Arrangement Exists. Prior to recognizing revenue on an arrangement, our customary policy is to have a written contract, signed by both the customer and by us or a purchase order from those customers that have previously negotiated a standard end-user license arrangement or purchase agreement. • Delivery Has Occurred. We deliver our products to our customers electronically or physically. For electronic deliveries, delivery occurs when we provide access to our customers to take immediate possession of the software through downloading it to the customer's hardware. For physical deliveries, the standard transfer terms are typically FOB shipping point. We generally ship our products or license keys promptly after acceptance of customer orders. However, a number of factors can affect the timing of product shipments and, as a result, timing of revenue recognition, including the delivery dates requested by customers and our operational capacity to fulfill product orders at the end of a fiscal quarter. 24 -------------------------------------------------------------------------------- Table of Contents • The Fee is Fixed or Determinable. Our determination that an arrangement fee is fixed or determinable depends principally on the arrangement's payment terms. Our standard payment terms for perpetual and term licenses require 75% or more of the license fee and 100% of the maintenance fee to be paid within one year. If the arrangement includes these terms, we regard the fee as fixed or determinable, and recognize all license revenue under the arrangement in full upon delivery (assuming all other revenue recognition criteria are met). If the arrangement does not include these terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable. In the case of a TSL, because of the right to exchange products or receive unspecified future technology and because VSOE for maintenance services does not exist for a TSL, we recognize revenue ratably over the term of the license, but not in advance of when customers' installments become due and payable. • Collectability is Probable. We judge collectability of the arrangement fees on a customer-by-customer basis pursuant to our credit review policy. We typically sell to customers with whom we have a history of successful collection. For a new customer, or when an existing customer substantially expands its commitments, we evaluate the customer's financial position and ability to pay and typically assign a credit limit based on that review. We increase the credit limit only after we have established a successful collection history with the customer. If we determine at any time that collectability is not probable under a particular arrangement based upon our credit review process or the customer's payment history, we recognize revenue under that arrangement as customer payments are actually received. Results of Operations Revenue Background We generate our revenue from the sale of software licenses, maintenance and professional services and to a small extent, hardware products. Under current accounting rules and policies, we recognize revenue from orders we receive for software licenses, services and hardware products at varying times. In most instances, we recognize revenue on a TSL software license order over the license term and on a term or perpetual software license order in the quarter in which the license is delivered. Substantially all of our current time-based licenses are TSLs with an average license term of approximately three years. Revenue on maintenance orders is recognized ratably over the maintenance period (normally one year). Revenue on professional services orders is generally recognized upon completion and customer acceptance of contractually agreed milestones. Revenue on contracts requiring significant modification or development is accounted for using the percentage of completion method over the period of the development. Revenue on hardware product orders is generally recognized in full at the time the product is shipped. Our revenue in any fiscal quarter is equal to the sum of our time-based license, upfront license, maintenance and professional services and hardware revenue for the period. We derive time-based license revenue in any quarter largely from TSL orders received and delivered in prior quarters and to a smaller extent due to contracts in which revenue is recognized as customer installments become due and payable and from contingent revenue arrangements. We derive upfront license revenue directly from term and perpetual license and hardware product orders mostly booked and shipped during the quarter. We derive maintenance revenue in any quarter largely from maintenance orders received in prior quarters since our maintenance orders generally yield revenue ratably over a term of one year. We also derive professional services revenue primarily from orders received in prior quarters, since we recognize revenue from professional services as those services are delivered and accepted, not when they are booked. Our license revenue is sensitive to the mix of TSLs and perpetual or term licenses delivered during a reporting period. A TSL order typically yields lower current quarter revenue but contributes to revenue in future periods. For example, a $120,000 order for a three-year TSL delivered on the last day of a quarter typically generates no revenue in that quarter, but $10,000 in each of the twelve succeeding quarters. Conversely, perpetual and term licenses with greater than 75% of the license fee due within one year from shipment typically generate current quarter revenue but no future revenue (e.g., a $120,000 order for a perpetual license generates $120,000 in revenue in the quarter the product is delivered, but no future revenue). Additionally, revenue in a particular quarter may also be impacted by perpetual and term licenses in which less than 75% of the license fees and 100% of the maintenance fees are payable within one year from shipment as the related revenue will be recognized as revenue in the period when customer payments become due and payable. Our customer arrangements are complex, involving hundreds of products and various license rights, and our customers bargain with us over many aspects of these arrangements. For example, they often demand a broader portfolio of solutions, support and services and seek more favorable terms such as expanded license usage, future purchase rights and other unique rights at an overall lower total cost. No single factor typically drives our customers' buying decisions, and 25 -------------------------------------------------------------------------------- Table of Contents we compete on all fronts to serve customers in a highly competitive EDA market. Customers generally negotiate the total value of the arrangement rather than just unit pricing or volumes. Total Revenue July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 386.8 $ 336.9 $ 49.9 15 % Nine months ended $ 1,145.1 $ 1,005.2 $ 139.9 14 % Our revenues are subject to fluctuations, primarily due to customer requirements, including payment terms, the timing and value of contract renewals and the sale of products associated with prior-year acquisitions. The increase in total revenue for the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 was due to our overall growth and the related increase in time-based revenue, upfront revenue and professional services revenue primarily driven by the timing and value of contract renewals, sales of products and professional services contracts including contracts assumed from our prior-year acquisitions. Time-Based License Revenue July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 322.1 $ 286.6 $ 35.5 12 % Percentage of total revenue 83 % 85 % Nine months ended $ 936.5 $ 847.7 $ 88.8 10 % Percentage of total revenue 82 % 84 % The increase in time-based license revenue for the three months and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 was primarily attributable to increases in TSL license revenue from arrangements booked in prior periods, higher contingent revenue and product sales from prior-year acquisitions. Upfront License Revenue July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 19.0 $ 14.7 $ 4.3 29 % Percentage of total revenue 5 % 4 % Nine months ended $ 70.6 $ 47.8 $ 22.8 48 % Percentage of total revenue 6 % 5 % Changes in upfront license revenue are generally attributable to normal fluctuations in customer requirements which can drive the amount of upfront orders and revenue in any particular period. The increase in upfront license revenue for the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 was primarily attributable to the increase in sales of our hardware products, perpetual licenses and new products associated with prior-year acquisitions. 26-------------------------------------------------------------------------------- Table of Contents Maintenance and Service Revenue July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended Maintenance revenue $ 18.7 $ 19.9 $ (1.2 ) (6 )%Professional services and other revenue 26.9 15.8 11.1 70 % Total maintenance and services revenue $ 45.6 $ 35.7 $ 9.9 28 % Percentage of total revenue 12 % 11 % Nine months ended Maintenance revenue $ 59.0 $ 59.0 $ - - %Professional services and other revenue 79.0 50.7 28.3 56 % Total maintenance and services revenue $ 138.0 $ 109.7 $ 28.3 26 % Percentage of total revenue 12 % 11 % Maintenance revenue was relatively flat for the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 primarily due to the timing of renewals of maintenance contracts. Professional services and other revenue increased substantially in the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010, primarily due to professional services contracts assumed from prior acquisitions. Cost of Revenue July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended Cost of license revenue $ 52.1 $ 44.0 $ 8.1 18 % Cost of maintenance and service revenue 19.2 14.7 4.5 31 % Amortization of intangible assets 13.4 8.0 5.4 68 % Total $ 84.7 $ 66.7 $ 18.0 27 % Percentage of total revenue 22 % 20 % Nine months ended Cost of license revenue $ 153.8 $ 130.2 $ 23.6 18 % Cost of maintenance and service revenue 59.8 46.5 13.3 29 % Amortization of intangible assets 41.5 24.7 16.8 68 % Total $ 255.1 $ 201.4 $ 53.7 27 % Percentage of total revenue 22 % 20 % We divide cost of revenue into three categories: cost of license revenue, cost of maintenance and service revenue, and amortization of intangible assets. We segregate expenses directly associated with consulting and training services from cost of license revenue associated with internal functions providing license delivery and post-customer contract support services. We then allocate these group costs between cost of license revenue and cost of maintenance and service revenue based on license and maintenance and service revenue reported. Cost of license revenue. Cost of license revenue includes costs related to products sold and software licensed, allocated operating costs related to product support and distribution costs, royalties paid to third party vendors, and the amortization of capitalized research and development costs associated with software products which have reached technological feasibility. Cost of maintenance and service revenue. Cost of maintenance and service revenue includes operating costs related to maintaining the infrastructure necessary to operate our services and training organization, and costs associated with the delivery of our consulting services, such as hotline and on-site support, production services and documentation of maintenance updates. 27-------------------------------------------------------------------------------- Table of Contents Amortization of intangible assets. Intangible assets are amortized to cost of revenue and operating expenses, and include the contract rights associated with certain contracts and core/developed technology, trademarks, trade names, customer relationships, covenants not to compete and other intangibles related to acquisitions. The increase in cost of revenue in the three months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily due to an increase of $6.4 million in personnel-related costs as a result of headcount increases from our prior-year acquisitions, an increase of $5.0 million in maintenance and professional services driven by higher consulting service activities, and an increase of $5.4 million for amortization of intangible assets due to our prior-year acquisitions. The increase in cost of revenue in the nine months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily due to an increase in $15.0 million in personnel-related costs as a result of headcount increases from our prior-year acquisitions, an increase of $15.1 million in maintenance and professional services, an increase of $3.9 million in hardware and license costs, and an increase of $16.8 million for amortization of intangible assets due to our prior-year acquisitions. As a percentage of total revenue, cost of revenue marginally increased in the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 due to an increase in professional services contracts and an increase in amortization of intangible assets assumed in our prior-year acquisitions. Operating Expenses Research and Development July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 122.5 $ 105.6 $ 16.9 16 % Percentage of total revenue 32 % 31 % Nine months ended $ 366.5 $ 319.9 $ 46.6 15 % Percentage of total revenue 32 % 32 % The increase in research and development expenses in the three months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily due to an increase of $13.3 million in personnel-related costs and an increase of $2.9 million in functionally allocated expenses as a result of headcount increases from our prior-year acquisitions. The increase in research and development expenses for the nine months ended July 31, 2011 compared with the same period in fiscal 2010 was primarily due to an increase of $33.7 million in personnel-related costs, an increase of $11.1 million in functionally allocated expenses as a result of headcount increases from our prior-year acquisitions, and $3.6 million of other expenses including third party contractor services, partially offset by a decrease of $3.7 million due to change in the fair value of contingent consideration related to a prior-year acquisition. Sales and Marketing July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 90.7 $ 83.8 $ 6.9 8 % Percentage of total revenue 23 % 25 % Nine months ended $ 269.6 $ 242.8 $ 26.8 11 % Percentage of total revenue 24 % 24 % The increase in sales and marketing expenses for the three months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily attributable to higher variable compensation of $2.4 million driven by timing of shipments based on contract requirements and the increase in license revenues, and an increase of $4.3 million in other personnel-related costs due to an increase in headcount from prior-year acquisitions. The increase in sales and marketing expenses for the nine months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily attributable to higher variable compensation of $12.8 million driven by the volume of contracts and timing of shipments based on contract requirements and the increase in license revenues, an increase of $10.0 million in other personnel-related costs due to an increase in headcount from prior-year acquisitions, and an increase of $2.3 million in travel-related costs. 28-------------------------------------------------------------------------------- Table of Contents General and Administrative July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended $ 27.1 $ 27.4 $ (0.3 ) (1 )% Percentage of total revenue 7 % 8 % Nine months ended $ 86.4 $ 81.9 $ 4.5 5 % Percentage of total revenue 8 % 8 % General and administrative expenses for the three months ended July 31, 2011 compared to the same period in fiscal 2010 were relatively flat. The decrease of $2.3 million in functionally allocated expenses as a result of increased headcount in other functional areas was offset by an increase of $2.8 million in personnel-related costs and facility expenses as a result of headcount increases from our prior-year acquisitions. The increase in general and administrative expenses for the nine months ended July 31, 2011 compared to the same period in fiscal 2010 was primarily due to an increase of $5.7 million in personnel-related costs, $6.7 million in facility expenses and $4.0 million in other general and administrative expenses primarily as a result of headcount increases from our prior-year acquisitions. The increases were partially offset by a decrease of $13.5 million in functionally allocated expenses as a result of increased headcount in other functional areas. Amortization of Intangible Assets July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended Included in cost of revenue $ 13.4 $ 8.0 $ 5.4 68 % Included in operating expenses 3.6 2.6 1.0 38 % Total $ 17.0 $ 10.6 $ 6.4 60 % Percentage of total revenue 4 % 3 % Nine months ended Included in cost of revenue $ 41.5 $ 24.7 $ 16.8 68 % Included in operating expenses 11.1 8.3 2.8 34 % Total $ 52.6 $ 33.0 $ 19.6 59 % Percentage of total revenue 5 % 3 % The increase in amortization of intangible assets for the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 was due to the amortization of intangible assets from our prior-year acquisitions, partially offset by certain intangible assets becoming fully amortized. See Note 5 to Notes to Unaudited Condensed Consolidated Financial Statements for a schedule of future amortization amounts. 29 -------------------------------------------------------------------------------- Table of Contents Other (expense) income, net July 31, Dollar 2011 2010 Change % Change (dollars in millions) Three months ended Interest income $ 0.5 $ 1.3 $ (0.8 ) (62 )% Loss on assets related to deferred compensation plan (2.8 ) (2.2 ) (0.6 ) 27 % Foreign currency exchange (loss) gain (0.4 ) (1.2 ) 0.8 (67 )% Write-down of long-term investments - (0.5 ) 0.5 (100 )% Other, net 0.5 (0.4 ) 0.9 (225 )% Total $ (2.2 ) $ (3.0 ) $ 0.8 (27 )% Nine months ended Interest income $ 1.7 $ 4.5 $ (2.8 ) (62 )% Gain on assets related to deferred compensation plan 5.8 3.7 2.1 57 % Foreign currency exchange (loss) gain 1.7 (1.2 ) 2.9 (242 )% Write-down of long-term investments (1.0 ) (0.5 ) (0.5 ) 100 % Other, net 0.8 1.6 (0.8 ) (50 )% Total $ 9.0 $ 8.1 $ 0.9 11 % Other (expense) income, net, increased during the three and nine months ended July 31, 2011 compared to the same periods in fiscal 2010 due to the changes described above. Taxes Our effective tax rate for the three months ended July 31, 2011 as compared to the three months ended July 31, 2010 is lower principally due to the benefit of additional tax credits and deductions which were higher than those previously estimated as a result of the filing of the Company's federal tax return for the fiscal 2010, the impact of an entire year of federal research and development tax credit in fiscal 2011 versus only two months in fiscal 2010 and the reversal of valuation allowance for capital losses in the third quarter of fiscal 2011. Our effective tax rates for the nine months ended July 31, 2011 and 2010 are negative, primarily due to the tax impact of a final settlement with the IRS for fiscal years 2006 through 2009 of $32.8 million in fiscal 2011 and the final settlement with the IRS for fiscal years 2002 through 2004 of $94.3 million in fiscal 2010. Without the impact of the settlements, the tax rate for the nine months ended July 31, 2011 and 2010 would have been 10.2% and 26.2%, respectively. For further discussion of the effective tax rate and the IRS settlement, see Note 14 of the Notes to Unaudited Condensed Consolidated Financial Statements. Liquidity and Capital Resources Our sources of cash, cash equivalents and short-term investments are funds generated from our business operations and funds that may be drawn down under our credit facility. As of July 31, 2011, we held an aggregate of $337.7 million in cash, cash equivalents and short-term investments in the U.S. and an aggregate of $700.6 million in our foreign subsidiaries. Funds held in our foreign subsidiaries are generated from revenue outside North America. At present, such foreign funds are considered to be indefinitely reinvested in foreign countries to the extent of indefinitely reinvested foreign earnings. However, in the event funds from foreign operations were needed to fund cash needs in the U.S. and if U.S. taxes have not already been previously accrued, we would be required to accrue and pay additional U.S. taxes in order to repatriate these funds. The following sections discuss changes in our balance sheet and cash flows, and other commitments on our liquidity and capital resources during fiscal 2011. 30 -------------------------------------------------------------------------------- Table of Contents Cash and Cash Equivalents and Short-Term Investments July 31, October 31, Dollar 2011 2010 Change % Change (dollars in millions) Cash and cash equivalents $ 889.9 $ 775.4 $ 114.5 15 % Short-term investments 148.4 163.2 (14.8 ) (9 )% Total $ 1,038.3 $ 938.6 $ 99.7 11 % During the nine months ended July 31, 2011, our primary sources and uses of cash consisted of (1) cash provided by operating activities of $367.3 million, (2) proceeds from sales and maturities of short-term investments of $104.0 million, (3) purchases of investments of $92.6 million, (4) cash paid for purchases of property and equipment of $42.8 million, (5) proceeds from the issuance of common stock of $119.8 million for stock awards and (6) repurchases of common stock of $335.0 million. Cash Flows July 31, Dollar 2011 2010 Change % Change (dollars in millions) Nine months ended Cash provided by operating activities $ 367.3 $ 244.1 $ 123.2 50 % Cash used in investing activities (39.1 ) (24.8 ) (14.3 ) 58 % Cash used in financing activities (219.8 ) (41.6 ) (178.2 ) 428 % We expect cash from our operating activities to fluctuate in future periods as a result of a number of factors, including the timing of our billings and collections, our operating results, the timing and amount of tax and other liability payments. Cash provided by our operations is dependent primarily upon the payment terms of our license agreements. We generally receive cash from upfront license revenue much sooner than from time-based license revenue. In contrast, payment terms for TSLs are generally extended and the license fee is typically paid either quarterly or annually over the term of the license. Cash provided by operating activities. Cash provided by operations is dependent primarily upon the payment terms of our license agreements. To be classified as upfront revenue, we require that 75% of a term or perpetual license fee be paid within the first year. Conversely, terms for TSLs are generally extended and the license fee is typically paid either quarterly or annually over the term of the license. Accordingly, we generally receive cash from upfront license revenue much sooner than from time-based license revenue. Cash provided by operating activities increased in the nine months ended July 31, 2011 compared to the same period in fiscal 2010, primarily due to fluctuation in operating assets and liabilities resulting from changes in deferred revenue balances based on timing of release, an increase in collections from customers, offset by higher payments to vendors, and an increase in inventory balances. Cash used in investing activities. The decrease in cash used in investing activities in the nine months ended July 31, 2011 compared to the same period in fiscal 2010 is due to higher cash used for capital expenditures in fiscal 2011 and higher net proceeds from short-term investments activity in fiscal 2010, offset by lower cash payments for acquisitions in 2011. Cash used in financing activities. The increase in cash used in financing activities in the nine months ended July 31, 2011 compared to the same period in fiscal 2010 primarily relates to common stock repurchases under our stock repurchase program, partially offset by issuances of our common stock under our stock compensation plans. See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements for details of our stock repurchase program. 31 -------------------------------------------------------------------------------- Table of Contents Accounts Receivable, net July 31, October 31, Dollar 2011 2010 Change % Change (dollars in millions) $ 175.4 $181.1 $(5.7) (3)% Our accounts receivable and Days Sales Outstanding (DSO) are primarily driven by our billing and collections activities. Our DSO was 41 days at July 31, 2011, and 44 days at October 31, 2010. The decrease in DSO and in net accounts receivable primarily relates to the timing of billings to customers during fiscal 2011. Working Capital. Working capital is comprised of current assets less current liabilities, as shown on our consolidated balance sheets: July 31, October 31, 2011 2010 Dollar Change % Change (dollars in millions) Current assets $ 1,362.3 $ 1,247.8 $ 114.5 9 % Current liabilities 982.1 921.8 60.3 7 % Working capital $ 380.2 $ 326.0 $ 54.2 17 % Changes in our working capital were primarily due to (1) a $99.7 million increase in cash, cash equivalents and short-term investments, (2) a decrease of $28.4 million in accounts payable and accrued liabilities, (3) a $94.0 million increase in deferred revenue due to timing of our billings and (4) a net $14.8 million increase in accounts receivable and other current assets balances primarily related to movements in foreign exchange contract fair values, timing of inventory purchases, income tax balances and increased receivables from the sale of strategic investments during the first 3 quarters of our fiscal year. Other Commitments-Revolving Credit Facility. On October 20, 2006, we entered into a five-year, $300.0 million senior unsecured revolving credit facility providing for loans to us and certain of our foreign subsidiaries. The facility contains financial covenants requiring us to maintain a minimum leverage ratio and specified levels of cash, as well as other non-financial covenants. The facility terminates on October 20, 2011. Borrowings under the facility bear interest at the greater of the administrative agent's prime rate or the federal funds rate plus 0.50%; however, we have the option to pay interest based on the outstanding amount at Eurodollar rates plus a spread between 0.50% and 0.70% based on a pricing grid tied to a financial covenant. In addition, commitment fees are payable on the facility at rates between 0.125% and 0.175% per year based on a pricing grid tied to a financial covenant. As of July 31, 2011, we had no outstanding borrowings under this credit facility and were in compliance with all covenants. Other Our cash equivalent and short-term investment portfolio as of July 31, 2011, consists of investment grade municipal securities, tax-exempt money market mutual funds and taxable money market mutual funds. We follow an established investment policy and set of guidelines to monitor, manage and limit our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer. As of July 31, 2011, we had no direct holdings in structured investment vehicles, sub-prime mortgage-backed securities or collateralized debt obligations and no exposure to these financial instruments through our indirect holdings in money market mutual funds. During the three and nine months ended July 31, 2011 and 2010, we had no impairment charge associated with our short-term investment portfolio. While we cannot predict future market conditions or market liquidity, we regularly review our investments and associated risk profiles, which we believe will allow us to effectively manage the risks of our investment portfolio. As a result of the challenging conditions in the financial markets, we proactively manage our cash and cash equivalents and investments balances and closely monitor our capital and stock repurchase expenditures to ensure ample liquidity. Additionally, we believe the overall credit quality of our portfolio is strong, with our global excess cash, and our cash equivalents and fixed income portfolio invested in banks and securities with a weighted-average credit rating exceeding AA. After the recent downgrade of the U.S. long-term sovereign credit rating by Standard & Poor's, our portfolio maintained its weighted average credit rating above AA. The majority of our investments are classified as Level 1 or Level 2 investments, as measured under fair value guidance. See Notes 3 and 4 of the Notes to Unaudited Condensed Consolidated Financial Statements. We believe that our current cash, cash equivalents, short-term investments, and cash generated from operations will satisfy our business requirements for at least the next twelve months. 32-------------------------------------------------------------------------------- Table of Contents Effect of New Accounting Pronouncements See Note 16 of the Notes to Unaudited Condensed Consolidated Financial Statements. |