TMCnet News
ANSYS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview: ANSYS, Inc.'s results for the three months ended March 31, 2013 reflect growth in revenues of 6.7%, operating income of 2.5% and diluted earnings per share of 12.5% as compared to the three months ended March 31, 2012. The Company experienced higher revenues in 2013 from growth in both license and maintenance revenue, and from the acquisition of Esterel. Revenue was adversely impacted by the overall strengthening of the U.S. Dollar against the Company's primary foreign currencies. The net overall strengthening decreased revenue by $4.7 million for the three months ended March 31, 2013, as compared to the same period in 2012. The growth in revenue was partially offset by increased operating expenses, including expenses related to the August 2012 acquisition of Esterel. The net overall strengthening of the U.S. Dollar reduced operating income during the three months ended March 31, 2013 by $3.2 million as compared to the same period in 2012. The Company's non-GAAP results for the three months ended March 31, 2013 reflect increases in revenue of 6.4%, operating income of 1.8% and diluted earnings per share of 7.6% as compared to the three months ended March 31, 2012. The non-GAAP results exclude the income statement effects of the acquisition accounting adjustment to deferred revenue, stock-based compensation, acquisition-related amortization of intangible assets and transaction costs related to business combinations. For further disclosure regarding non-GAAP results, see the section titled "Non-GAAP Results" immediately preceding the section titled "Liquidity and Capital Resources". The Company's financial position includes $651.5 million in cash and short-term investments, and working capital of $512.3 million as of March 31, 2013. The Company has outstanding borrowings under its term loan of $26.6 million, which are scheduled to be paid at maturity on July 31, 2013. ANSYS develops and globally markets engineering simulation software and services widely used by engineers, designers, researchers and students across a broad spectrum of industries and academia, including aerospace, automotive, manufacturing, electronics, biomedical, energy and defense. Headquartered south of Pittsburgh, Pennsylvania, the Company and its subsidiaries employed approximately 2,500 people as of March 31, 2013 and focus on the development of open and flexible solutions that enable users to analyze designs directly on the desktop, providing a common platform for fast, efficient and cost-conscious product development, from design concept to final-stage testing and validation. The Company distributes its ANSYS suite of simulation technologies through a global network of independent channel partners and direct sales offices in strategic, global locations. It is the Company's intention to continue to maintain this hybrid sales and distribution model. The Company licenses its technology to businesses, educational institutions and governmental agencies. Growth in the Company's revenue is affected by the strength of global economies, general business conditions, currency exchange rate fluctuations, customer budgetary constraints and the competitive position of the Company's products. The Company believes that the features, functionality and integrated multiphysics capabilities of its software products are as strong as they have ever been. However, the software business is generally characterized by long sales cycles. These long sales cycles increase the difficulty of predicting sales for any particular quarter. The Company makes many operational and strategic decisions based upon short- and long-term sales forecasts that are impacted not only by these long sales cycles but by current global economic conditions. As a result, the Company believes that its overall performance is best measured by fiscal year results rather than by quarterly results. The Company's management considers the competition and price pressure that it faces in the short- and long-term by focusing on expanding the breadth, depth, ease of use and quality of the technologies, features, functionality and integrated multiphysics capabilities of its software products as compared to its competitors; investing in research and development to develop new and innovative products and increase the capabilities of its existing products; supplying new products and services; focusing on customer needs, training, consulting and support; and enhancing its distribution channels. From time to time, the Company also considers acquisitions to supplement its global engineering talent, product offerings and distribution channels. Geographic Trends: During the quarter ended March 31, 2013, North America continued to experience ongoing cautious customer sentiment in many sectors. North America had relative sales strength in automotive, industrial equipment and electronics, while there was notable softness in oil and gas. The sales pipelines have been strengthening and customer engagement activities in North America are building as the Company sees innovation and competitive pressures continuing to drive simulation investments. 16-------------------------------------------------------------------------------- Table of Contents Despite the ongoing macroeconomic concerns in Europe, the Company saw solid growth in constant currency for the region when compared to the prior-year first quarter, most notably in the United Kingdom. While volatility and prolonged customer procurement processes continued to impact the closing of new business, the overall renewal rates were in line with those of the first quarter of 2012 and customer engagements in Europe remained intact, albeit extended. The services business in Europe was also weaker than planned as customers delayed projects due to concerns in their own businesses. With the exception of India, the Company's General International Area, which includes all geographies other than North America and Europe, showed progress when compared to the prior-year first quarter. Particularly notable was the growth in China and South Korea, as well as improvement in Japan. Consistent with the Company's experience in fiscal year 2012, the Japan economy continued to struggle with ongoing macroeconomic issues, and the weakening of the Yen impacted our reported results. The Company is focused on hiring in marketplaces where it still sees opportunity for additional growth. The sales teams are also seeking new and complementary ways to better address the market opportunities in local geographies and to increase overall sales productivity. Industry Highlights: During the quarter ended March 31, 2013, the Company experienced growth from a combination of large domestic accounts, multi-nationals, emerging markets and industry verticals with time-sensitive, complex, multi-physics challenges. The Company's revenue is derived from customers in many different industries, with no industry accounting for more than 20% of the Company's sales. Although customers from all industries contributed to the 2013 first quarter results, there were a few sectors where the activity was more notable than the others, as explained below. Automotive A variety of factors are positively affecting the automotive sector from a simulation perspective, including fuel economy and emissions regulations; demand for an enhanced passenger experience; competition for emerging market share; warranty reductions; avoidance of catastrophic failures; and manufacturing innovation for cost and quality. The implications of these drivers are resulting in increased vehicle electrification and renewed research and development in traditional technologies such as the development of internal combustion powertrains, reduced weight specifications, and improved aerodynamics. In the race to capture fast-growing markets in developing countries, automotive companies are challenged with balancing globalized product development, product and electronics proliferation and complying with various market rules and regulations, all of which are areas requiring the breadth and depth of the Company's product portfolio. Electronics and Semiconductors The Company has seen some recovery in the electronics and semiconductor sectors, with a variety of market trends and drivers that are changing the way that high-tech products are being developed. Specific drivers include transistor miniaturization and 3-D integrated circuit designs, improved power consumption, higher signal speed and bandwidth, mobility and platform integration, the proliferation of electronics and embedded software across industries, and governmental regulations and environmental issues. These trends are resulting in more complex and integrated chip-package-system designs; the need for a systems engineering approach to optimize product requirements by using simulation earlier in the design cycle; reduced error margins in power delivery and timing; improved package reliability; the need to address structural, thermal and electro-migration challenges; as well as the need to update existing design and manufacturing processes that can take into consideration the changes in material properties and manufacturing processes. Wireless and mobile devices continue to transform how people consume information and communicate, thus increasing the need for the Company's best-of-breed electronics and power products. 17-------------------------------------------------------------------------------- Table of Contents Industrial Equipment Industrial equipment plays a backstage role to the materials and goods that make modern life possible. Industrial robots keep the automotive industry moving; lathes and milling machines produce machine tools and parts; rotary separators help make mining more productive; paper machines are the foundation for newsprint production; heavy machinery makes modern road and building construction possible; and rolling machines transform steel into custom materials. Turbomachinery, such as compressors and turbines, plays a vital role in virtually all industries, including power generation, oil and gas, and transportation. Modern machines are electronics heavy, packed with features made possible by the recent rapid advances in electronics and computing. Competitive economics and consumer demand require high production rates while discerning businesses and consumers require high-quality products with tight tolerances. Factory machines must be precisely controlled while operating at high speeds. Such speed generates high inertial loads, requiring precise consideration of dynamics and resulting stresses. Many machines operate over a large range of operating conditions, requiring designers to consider thermal effects and their interaction with the machine's structural aspects. Modern machines often require expensive, high-performance engineering - so key design parameters include small size and low weight, but high strength and reliability. Today's machine designer faces a wide range of physical processes, demanding operational specifications and time-to-market pressures while customer expectations have never been higher. In some cases, energy efficiency is an important requirement, and this is particularly important to turbomachinery. During the first quarter of 2013, the Company saw strength in the turbomachinery business in North America (oil and gas, aircraft engines, turbochargers, etc.), coupled with high-performance computing ("HPC") demand, as the need for large-scale simulations continued to increase within this industry. Biomedical & Healthcare While the biomedical and healthcare industry is a smaller contributor to the Company's revenue today, companies within this segment are increasingly adopting simulation amid sharper global competition, tighter regulations and lower sales, leading to potential growth in this area. As the FDA process is becoming increasingly more difficult and lengthy, major companies are entering more attractive markets with more favorable approval processes (e.g. India and China), and are expanding their research and development centers and global footprint. This, in turn, is increasing the competitive pressure to release more new products at a faster pace, requiring the need for accelerated product throughput. At the same time, increased regulations and sanctions, the rising cost of health care, aging populations and the need for more accessible health care are all changing the way medical device products are being developed. As a result, the Company's initiatives in this area, including a formal marketing campaign and partnering with several organizations in the healthcare standards arena, produced promising growth in this segment during the first quarter of 2013. This growth is influenced by more market awareness of the need for innovative solutions, the introduction of new European regulations and the trend towards more patient-specific medicine. The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and notes thereto for the three months ended March 31, 2013, and with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2012 filed on the Annual Report on Form 10-K with the Securities and Exchange Commission. The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to fair value of stock awards, bad debts, contract revenue, valuation of goodwill, valuation of intangible assets, contingent consideration, deferred compensation, income taxes, and contingencies and litigation. The Company bases its estimates on historical experience, market experience, estimated future cash flows and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates. This Quarterly Report on Form 10-Q contains 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, including, but not limited to, the following statements, as well as statements that contain such words as "anticipates," "intends," "believes," "plans" and other similar expressions: • The Company's expectation that it will continue to make targeted investments in its global sales and marketing organization and its global business infrastructure to enhance major account sales activities and to support its worldwide sales distribution and marketing strategies, and the business in general. • The Company's intentions related to investments in research and development, particularly as it relates to expanding the capabilities of its flagship products and other products within its broad portfolio of simulation software, evolution of its ANSYS® Workbench™ platform, HPC capabilities, robust design and ongoing integration. • The Company's plans related to future capital spending. 18-------------------------------------------------------------------------------- Table of Contents • The Company's intentions regarding its hybrid sales and distribution model. • The sufficiency of existing cash and cash equivalent balances to meet future working capital, capital expenditure and debt service requirements. • The Company's assessment of the ultimate liabilities arising from various investigations, claims and legal proceedings. • The Company's statement regarding the competitive position and strength of its software products. • The Company's statement regarding increased exposure to volatility of foreign exchange rates. • The Company's intentions related to investments in complementary companies, products, services and technologies. • The Company's expectations regarding the impact of the merger of its Japan subsidiaries on future income tax expense and cash flows from operations. • The Company's estimates regarding the expected impact on reported revenue related to the acquisition accounting treatment of deferred revenue. • The Company's estimation that it is probable the key member of Apache's management will remain an employee of ANSYS on each of the first three anniversaries of the acquisition closing date. • The Company's belief that there is potential growth in simulation sales to the biomedical and healthcare industries. Forward-looking statements should not be unduly relied upon because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the Company's control. The Company's actual results could differ materially from those set forth in forward-looking statements. Certain factors, among others, that might cause such a difference include risks and uncertainties disclosed in the Company's most recent Annual Report on Form 10-K, Part I, Item 1A. Information regarding new risk factors or material changes to these risk factors have been included within Part II, Item 1A of this Quarterly Report on Form 10-Q. 19-------------------------------------------------------------------------------- Table of Contents Results of Operations Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012 Revenue: Three Months Ended March 31, Change (in thousands, except percentages) 2013 2012 Amount % Revenue: Lease licenses $ 72,911 $ 66,783 $ 6,128 9.2 Perpetual licenses 45,964 46,771 (807 ) (1.7 ) Software licenses 118,875 113,554 5,321 4.7 Maintenance 73,644 66,116 7,528 11.4 Service 5,213 5,675 (462 ) (8.1 ) Maintenance and service 78,857 71,791 7,066 9.8 Total revenue $ 197,732 $ 185,345 $ 12,387 6.7 The Company's revenue in the quarter ended March 31, 2013 increased 6.7% as compared to the quarter ended March 31, 2012. The growth was partially influenced by benefits from the Company's continued investment in its global sales and marketing organization and $3.7 million in Esterel-related revenue. Revenue from lease licenses increased 9.2% as compared to the quarter ended March 31, 2012 due primarily to growth in sales of Apache lease licenses. Annual maintenance contracts that were sold with new perpetual licenses, along with maintenance contracts sold with new perpetual licenses in previous quarters, contributed to maintenance revenue growth of 11.4%. Also contributing to this growth was the addition of Esterel-related maintenance revenue of $1.7 million. Perpetual license revenue, which is derived entirely from new sales during the quarter, decreased 1.7% as compared to the prior year quarter. Service revenue decreased 8.1% as compared to the prior year. With respect to revenue, on average for the quarter ended March 31, 2013, the U.S. Dollar was approximately 4.6% stronger, when measured against the Company's primary foreign currencies, than for the quarter ended March 31, 2012. The net overall strengthening resulted in decreased revenue and operating income of approximately $4.7 million and $3.2 million, respectively, during the quarter ended March 31, 2013, as compared with the same quarter of 2012. A substantial portion of the Company's license and maintenance revenue is derived from annual lease and maintenance contracts. These contracts are generally renewed on an annual basis and typically have a high rate of customer renewal. In addition to the recurring revenue base associated with these contracts, a majority of customers purchasing new perpetual licenses also purchase related annual maintenance contracts. As a result of the significant recurring revenue base, the Company's license and maintenance revenue growth rate in any period does not necessarily correlate to the growth rate of new license and maintenance contracts sold during that period. To the extent the rate of customer renewal for lease and maintenance contracts is high, incremental lease contracts, and maintenance contracts sold with new perpetual licenses, will result in license and maintenance revenue growth. Conversely, if the rate of renewal for these contracts is adversely affected by economic or other factors, the Company's license and maintenance growth will be adversely affected over the term that the revenue for those contracts would have otherwise been recognized. International and domestic revenues, as a percentage of total revenue, were 66.1% and 33.9%, respectively, during the quarter ended March 31, 2013, and 65.7% and 34.3%, respectively, during the quarter ended March 31, 2012. The Company derived 24.7% and 25.8% of its total revenue through the indirect sales channel for the quarters ended March 31, 2013 and 2012, respectively. In valuing deferred revenue on the Esterel and Apache balance sheets as of their respective acquisition dates, the Company applied the fair value provisions applicable to the accounting for business combinations. The impact on reported revenue for the three months ended March 31, 2013 was $1.8 million. 20-------------------------------------------------------------------------------- Table of Contents Deferred Revenue and Backlog: The deferred revenue on the Company's condensed consolidated balance sheets does not represent the total value of annual or multi-year, noncancellable lease license or maintenance agreements. Deferred revenue consists of billings made or payments received in advance of revenue recognition from lease license and maintenance agreements. The Company's backlog represents installment billings for periods beyond the current quarterly billing cycle or customer orders received but not invoiced. The Company's deferred revenue and backlog as of March 31, 2013 consisted of the following: Balance at March 31, 2013 (in thousands) Total Current Long-Term Deferred revenue $ 317,483 $ 306,801 $ 10,682 Backlog 81,219 33,428 47,791 Total $ 398,702 $ 340,229 $ 58,473 Revenue associated with deferred revenue and backlog that is expected to be recognized in the next twelve months is classified as current in the table above. Cost of Sales and Gross Profit: Three Months Ended March 31, 2013 2012 Change (in thousands, except % of % of percentages) Amount Revenue Amount Revenue Amount % Cost of sales: Software licenses $ 6,965 3.5 $ 5,996 3.2 $ 969 16.2 Amortization 9,874 5.0 10,214 5.5 (340 ) (3.3 ) Maintenance and service 19,395 9.8 18,132 9.8 1,263 7.0 Total cost of sales 36,234 18.3 34,342 18.5 1,892 5.5 Gross profit $ 161,498 81.7 $ 151,003 81.5 $ 10,495 7.0 Software Licenses: The increase in software license costs was primarily due to the following: • Increased third-party royalties of $400,000. • Increased salaries and other headcount-related costs of $400,000. Maintenance and Service: The increase in maintenance and service costs was primarily due to the following: • Increased salaries and other headcount-related costs of $600,000. • Increased third-party technical support costs of $400,000. • Esterel-related maintenance and service costs of $300,000. The improvement in gross profit was a result of the increase in revenue offset by a smaller increase in related cost of sales. 21-------------------------------------------------------------------------------- Table of Contents Operating Expenses: Three Months Ended March 31, 2013 2012 Change (in thousands, except % of % of percentages) Amount Revenue Amount Revenue Amount % Operating expenses: Selling, general and administrative $ 50,013 25.3 $ 45,249 24.4 $ 4,764 10.5 Research and development 36,007 18.2 31,501 17.0 4,506 14.3 Amortization 5,929 3.0 6,425 3.5 (496 ) (7.7 ) Total operating expenses $ 91,949 46.5 $ 83,175 44.9 $ 8,774 10.5 Selling, General and Administrative: The increase in selling, general and administrative costs was primarily due to the following: • Esterel-related selling, general and administrative expenses of $2.4 million. • Increased salaries and other headcount-related costs of $2.1 million. • Increased third-party commissions of $900,000. • Increased stock-based compensation expense of $600,000. • Decreased incentive compensation of $1.1 million. The Company anticipates that it will continue to make targeted investments in its global sales and marketing organization and its global business infrastructure to enhance major account sales activities and to support its worldwide sales distribution and marketing strategies, and the business in general. Research and Development: The increase in research and development costs was primarily due to the following: • Increased salaries and other headcount-related costs of $2.8 million. • Esterel-related research and development expenses of $900,000. • Increased stock-based compensation expense of $400,000. The Company has traditionally invested significant resources in research and development activities and intends to continue to make investments in this area, particularly as it relates to expanding the capabilities of its flagship products and other products within its broad portfolio of simulation software, evolution of its ANSYS® Workbench™ platform, HPC capabilities, robust design and ongoing integration. Interest Expense: The Company's interest expense consists of the following: Three Months Ended March 31, March 31, (in thousands) 2013 2012 Term loan $ 139 $ 428 Amortization of debt financing costs 92 204 Discounted obligations 122 158 Other 18 28 Total interest expense $ 371 $ 818 Interest Income: Interest income for the quarter ended March 31, 2013 was $732,000 as compared to $901,000 during the quarter ended March 31, 2012. Interest income decreased as a result of a decrease in the average rate of return on invested cash balances. Other Expense, net: The Company recorded other expense of $321,000 during the three months ended March 31, 2013 as compared to other expense of $616,000 during the three months ended March 31, 2012. The activity for both three-month periods was primarily composed of net foreign currency transaction losses. 22-------------------------------------------------------------------------------- Table of Contents Income Tax Provision: The Company recorded income tax expense of $18.6 million and had income before income taxes of $69.6 million for the quarter ended March 31, 2013. This represents an effective tax rate of 26.7% in the first quarter of 2013. During the quarter ended March 31, 2012, the Company recorded income tax expense of $21.8 million and had income before income taxes of $67.3 million. The Company's effective tax rate was 32.3% in the first quarter of 2012. When compared to the federal and state combined statutory rate, these rates were favorably impacted by lower statutory tax rates in many of the Company's foreign jurisdictions, the domestic manufacturing deduction, tax benefits associated with the merger of the Company's Japan subsidiaries in 2010, and research and experimentation credits. In the U.S., which is the largest jurisdiction where the Company receives such a tax credit, the availability of the research and development credit expired at the end of 2011. In January 2013, the U.S. Congress passed legislation that reinstated the research and development credit retroactive to 2012. The income tax provision in 2013 includes approximately $2.3 million related to the reinstated research and development credit for 2012 activity. These rates were also impacted by charges or benefits associated with the Company's uncertain tax positions. Net Income: The Company's net income in the first quarter of 2013 was $51.0 million as compared to net income of $45.5 million in the first quarter of 2012. Diluted earnings per share was $0.54 in the first quarter of 2013 and $0.48 in the first quarter of 2012. The weighted average shares used in computing diluted earnings per share were 95.2 million in both the first quarter of 2013 and 2012. 23-------------------------------------------------------------------------------- Table of Contents Non-GAAP Results The Company provides non-GAAP revenue, non-GAAP operating income, non-GAAP operating profit margin, non-GAAP net income and non-GAAP diluted earnings per share as supplemental measures to GAAP measures regarding the Company's operational performance. These financial measures exclude the impact of certain items and, therefore, have not been calculated in accordance with GAAP. A detailed explanation and a reconciliation of each non-GAAP financial measure to its most comparable GAAP financial measure are described below. Three Months Ended March 31, 2013 March 31, 2012 (in thousands, except percentages and per As Non-GAAP As Non-GAAP share data) Reported Adjustments Results Reported Adjustments Results Total revenue $ 197,732 $ 1,788 (1) $ 199,520 $ 185,345 $ 2,152 (4) $ 187,497 Operating income 69,549 26,556 (2) 96,105 67,828 26,593 (5) 94,421 Operating profit margin 35.2 % 48.2 % 36.6 % 50.4 % Net income $ 51,023 $ 16,729 (3) $ 67,752 $ 45,539 $ 17,396 (6) $ 62,935 Earnings per share - diluted: Diluted earnings per share $ 0.54 $ 0.71 $ 0.48 $ 0.66 Weighted average shares - diluted 95,166 95,166 95,190 95,190 (1) Amount represents the revenue not reported during the period as a result of the acquisition accounting adjustment associated with accounting for deferred revenue in business combinations. (2) Amount represents $15.8 million of amortization expense associated with intangible assets acquired in business combinations, $8.8 million of stock-based compensation expense, the $1.8 million adjustment to revenue as reflected in (1) above and $0.2 million of acquisition-related transaction expenses. (3) Amount represents the impact of the adjustments to operating income referred to in (2) above, adjusted for the related income tax impact of $9.8 million. (4) Amount represents the revenue not reported during the period as a result of the acquisition accounting adjustment associated with accounting for deferred revenue in business combinations. (5) Amount represents $16.6 million of amortization expense associated with intangible assets acquired in business combinations, $7.8 million of stock-based compensation expense and the $2.2 million adjustment to revenue as reflected in (4) above. (6) Amount represents the impact of the adjustments to operating income referred to in (5) above, adjusted for the related income tax impact of $9.2 million. Non-GAAP Measures Management uses non-GAAP financial measures (a) to evaluate the Company's historical and prospective financial performance as well as its performance relative to its competitors, (b) to set internal sales targets and spending budgets, (c) to allocate resources, (d) to measure operational profitability and the accuracy of forecasting, (e) to assess financial discipline over operational expenditures and (f) as an important factor in determining variable compensation for management and its employees. In addition, many financial analysts that follow the Company focus on and publish both historical results and future projections based on non-GAAP financial measures. The Company believes that it is in the best interest of its investors to provide this information to analysts so that they accurately report the non-GAAP financial information. Moreover, investors have historically requested and the Company has historically reported these non-GAAP financial measures as a means of providing consistent and comparable information with past reports of financial results. While management believes that these non-GAAP financial measures provide useful supplemental information to investors, there are limitations associated with the use of these non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with GAAP, are not reported by all of the Company's competitors and may not be directly comparable to similarly titled measures of the Company's competitors due to potential differences in the exact method of calculation. The Company compensates for these limitations by using these non-GAAP financial measures as supplements to GAAP financial measures and by reviewing the reconciliations of the non-GAAP financial measures to their most comparable GAAP financial measures. 24-------------------------------------------------------------------------------- Table of Contents The adjustments to these non-GAAP financial measures, and the basis for such adjustments, are outlined below: Acquisition accounting for deferred revenue and its related tax impact. Historically, the Company has consummated acquisitions in order to support its strategic and other business objectives. In accordance with the fair value provisions applicable to the accounting for business combinations, acquired deferred revenue is often recorded on the opening balance sheet at an amount that is lower than the historical carrying value. Although this purchase accounting requirement has no impact on the Company's business or cash flow, it adversely impacts the Company's reported GAAP revenue in the reporting periods following an acquisition. In order to provide investors with financial information that facilitates comparison of both historical and future results, the Company provides non-GAAP financial measures which exclude the impact of the acquisition accounting adjustment. The Company believes that this non-GAAP financial adjustment is useful to investors because it allows investors to (a) evaluate the effectiveness of the methodology and information used by management in its financial and operational decision-making and (b) compare past and future reports of financial results of the Company as the revenue reduction related to acquired deferred revenue will not recur when related annual lease licenses and software maintenance contracts are renewed in future periods. Amortization of intangibles from acquisitions and its related tax impact. The Company incurs amortization of intangibles, included in its GAAP presentation of amortization expense, related to various acquisitions it has made in recent years. Management excludes these expenses and their related tax impact for the purpose of calculating non-GAAP operating income, non-GAAP operating profit margin, non-GAAP net income and non-GAAP diluted earnings per share when it evaluates the continuing operational performance of the Company because these costs are fixed at the time of an acquisition, are then amortized over a period of several years after the acquisition and generally cannot be changed or influenced by management after the acquisition. Accordingly, management does not consider these expenses for purposes of evaluating the performance of the Company during the applicable time period after the acquisition, and it excludes such expenses when making decisions to allocate resources. The Company believes that these non-GAAP financial measures are useful to investors because they allow investors to (a) evaluate the effectiveness of the methodology and information used by management in its financial and operational decision-making and (b) compare past reports of financial results of the Company as the Company has historically reported these non-GAAP financial measures. Stock-based compensation expense and its related tax impact. The Company incurs expense related to stock-based compensation included in its GAAP presentation of cost of software licenses; cost of maintenance and service; research and development expense and selling, general and administrative expense. Although stock-based compensation is an expense of the Company and viewed as a form of compensation, management excludes these expenses for the purpose of calculating non-GAAP operating income, non-GAAP operating profit margin, non-GAAP net income and non-GAAP diluted earnings per share when it evaluates the continuing operational performance of the Company. Specifically, the Company excludes stock-based compensation during its annual budgeting process and its quarterly and annual assessments of the Company's and management's performance. The annual budgeting process is the primary mechanism whereby the Company allocates resources to various initiatives and operational requirements. Additionally, the annual review by the board of directors during which it compares the Company's historical business model and profitability to the planned business model and profitability for the forthcoming year excludes the impact of stock-based compensation. In evaluating the performance of senior management and department managers, charges related to stock-based compensation are excluded from expenditure and profitability results. In fact, the Company records stock-based compensation expense into a stand-alone cost center for which no single operational manager is responsible or accountable. In this way, management is able to review, on a period-to-period basis, each manager's performance and assess financial discipline over operational expenditures without the effect of stock-based compensation. The Company believes that these non-GAAP financial measures are useful to investors because they allow investors to (a) evaluate the Company's operating results and the effectiveness of the methodology used by management to review the Company's operating results, and (b) review historical comparability in its financial reporting as well as comparability with competitors' operating results. Transaction costs related to business combinations. The Company incurs expenses for professional services rendered in connection with business combinations, which are included in its GAAP presentation of selling, general and administrative expense. These expenses are generally not tax-deductible. Management excludes these acquisition-related transaction costs for the purpose of calculating non-GAAP operating income, non-GAAP operating profit margin, non-GAAP net income and non-GAAP diluted earnings per share when it evaluates the continuing operational performance of the Company, as it generally would not have otherwise incurred these expenses in the periods presented as a part of its continuing operations. The Company believes that these non-GAAP financial measures are useful to investors because they allow investors to (a) evaluate the Company's operating results and the effectiveness of the methodology used by management to review the Company's operating results, and (b) review historical comparability in its financial reporting as well as comparability with competitors' operating results. 25-------------------------------------------------------------------------------- Table of Contents Non-GAAP financial measures are not in accordance with, or an alternative for, GAAP. The Company's non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with the Company's consolidated financial statements prepared in accordance with GAAP. The Company has provided a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures as listed below: GAAP Reporting Measure Non-GAAP Reporting Measure Revenue Non-GAAP Revenue Operating Income Non-GAAP Operating Income Operating Profit Margin Non-GAAP Operating Profit Margin Net Income Non-GAAP Net IncomeDiluted Earnings Per Share Non-GAAP Diluted Earnings Per Share 26-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Cash, cash equivalents and short-term investments: As of March 31, 2013, the Company had cash, cash equivalents and short-term investments totaling $651.5 million and working capital of $512.3 million as compared to cash, cash equivalents and short-term investments of $577.2 million and working capital of $436.0 million at December 31, 2012. Cash and cash equivalents consist primarily of highly liquid investments such as money market mutual funds and deposits held at major banks. Short-term investments consist primarily of deposits held by certain foreign subsidiaries of the Company with original maturities of three months to one year. Cash, cash equivalents and short-term investments include $184.9 million held by the Company's foreign subsidiaries as of March 31, 2013. If these foreign balances were repatriated to the U.S., they would be subject to domestic tax, resulting in a tax obligation in the period of repatriation. The amount of cash, cash equivalents and short-term investments held by these subsidiaries is subject to translation adjustments caused by changes in foreign currency exchange rates as of the end of each respective reporting period, the offset to which is recorded in accumulated other comprehensive income on the Company's condensed consolidated balance sheet. Cash flows from operating activities: The Company's operating activities provided cash of $95.4 million for the three months ended March 31, 2013 and $83.6 million for the three months ended March 31, 2012. The net $11.8 million increase in operating cash flows in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 was primarily related to: • An $8.7 million increase in cash flows from operating assets and liabilities whereby these fluctuations produced a net cash inflow of $20.3 million during the three months ended March 31, 2013 as compared to $11.6 million during the three months ended March 31, 2012. • An increase in net income of $5.5 million from $45.5 million for the three months ended March 31, 2012 to $51.0 million for the three months ended March 31, 2013. • A decrease in other non-cash operating adjustments of $2.3 million from $26.4 million for the three months ended March 31, 2012 to $24.1 million for the three months ended March 31, 2013. Cash flows from investing activities: The Company's investing activities used cash of $4.1 million and $4.7 million for the three months ended March 31, 2013 and March 31, 2012, respectively. The investing activities for both periods were primarily composed of capital spending on property and equipment. The Company currently plans capital spending of approximately $35 million to $45 million during fiscal year 2013 as compared to $24.0 million of capital spending during fiscal year 2012. The planned increase is attributable to costs associated with the Company's new headquarters facility to be completed in late 2014 and the outfit of its new data center and customer training space, both in Canonsburg, Pennsylvania. However, the level of spending will be dependent upon various factors, including growth of the business and general economic conditions. Cash flows used in financing activities: Financing activities used cash of $11.9 million for the three months ended March 31, 2013 and provided cash of $2.4 million for the three months ended March 31, 2012. This change of $14.3 million was primarily the result of a $15.9 million increase in the scheduled principal payments on long-term debt during the 2013 period as compared to the 2012 period. The Company's term loan includes covenants related to the consolidated leverage ratio and the consolidated fixed charge coverage ratio, as well as certain restrictions on additional investments and indebtedness. As of March 31, 2013, the Company is in compliance with all financial covenants as stated in the credit agreement. The Company is scheduled to make its final debt payment on July 31, 2013. The Company believes that existing cash and cash equivalent balances of $651.0 million, together with cash generated from operations, will be sufficient to meet the Company's working capital, capital expenditure and debt service requirements through the next twelve months. The Company's cash requirements in the future may also be financed through additional equity or debt financings. There can be no assurance that such financings can be obtained on favorable terms, if at all. As of March 31, 2013, 3.0 million shares remain authorized for repurchase under the Company's stock repurchase program. The Company continues to generate positive cash flows from operating activities and believes that the best use of its excess cash is to repay its long-term debt, to invest in the business and, under certain favorable conditions, to repurchase stock. Additionally, the Company has in the past, and expects in the future, to acquire or make investments in complementary companies, products, services and technologies. Any future acquisitions may be funded by available cash and investments, cash generated from operations, existing or additional credit facilities, or from the issuance of additional securities. Off-Balance Sheet Arrangements The Company does not have any special purpose entities or off-balance sheet financing. 27-------------------------------------------------------------------------------- Table of Contents Contractual Obligations There were no material changes to the Company's significant contractual obligations during the three months ended March 31, 2013 as compared to those previously reported in "Management's Discussion and Analysis of Financial Condition and Results of Operations" within the Company's most recent Annual Report on Form 10-K. Critical Accounting Policies and Estimates No significant changes have occurred to the Company's critical accounting policies and estimates as previously reported within "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's most recent Annual Report on Form 10-K. During the first quarter of 2013, the Company completed the annual impairment test for goodwill and intangible assets with indefinite lives and determined that these assets had not been impaired as of the test date, January 1, 2013. As of the test date, there was sufficient evidence that it was not more likely than not that the fair values of the Company's reporting units and intangible assets were less than their carrying values. No events occurred or circumstances changed during the three months ended March 31, 2013 that would indicate that the fair values of the Company's reporting units or intangible assets are below their carrying amounts. 28-------------------------------------------------------------------------------- Table of Contents |