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MENTOR GRAPHICS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Unless otherwise indicated, numerical references are in millions, except for percentages, per share data, and conversion rate data. Overview The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this Form 10-Q. Certain of the statements below contain forward-looking statements. These statements are predictions based upon our current expectations about future trends and events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. In particular, we refer you to the risks discussed in Part II, Item 1A. "Risk Factors" and in our other Securities and Exchange Commission filings, which identify important risks and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements. We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Form 10-Q. All subsequent written or spoken forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Form 10-Q are made only as of the date of this Form 10-Q. We do not intend, and undertake no obligation, to update these forward-looking statements. The Company We are a supplier of electronic design automation (EDA) tools - advanced computer software and emulation hardware systems used to automate the design, analysis, and testing of complex electro-mechanical systems, electronic hardware, and embedded systems software in electronic systems and components. We market our products and services worldwide, primarily to large companies in the communications, computer, consumer electronics, semiconductor, networking, military/aerospace, multimedia, and transportation industries. Through the diversification of our customer base among these various customer markets, we attempt to reduce our exposure to fluctuations within each market. We sell and license our products through our direct sales force and a channel of distributors and sales representatives. In addition to our corporate offices in Wilsonville, Oregon, we have sales, support, product development, and professional service offices worldwide. We focus on products and design platforms where we have or believe we can attain leading market share. Part of this approach includes developing new applications and exploring new markets where EDA companies have not generally participated. We believe this strategy leads to a more diversified product and customer mix and can help reduce the volatility of our business and our risk as a creditor, while increasing our potential for growth. We derive system and software revenues primarily from the sale of term software license contracts, which are typically three to four years in length. We generally recognize revenue for these arrangements upon product delivery at the beginning of the license term. Larger enterprise-wide customer contracts, which are approximately 50% or more of our system and software revenue, drive the majority of our period-to-period revenue variances. We identify term licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues primarily include short-term term licenses. For these reasons, the timing of large contract renewals, customer circumstances, and license terms are the primary drivers of revenue changes from period to period, with revenue changes also being driven by new contracts and additional purchases under existing contracts, to a lesser extent. The EDA industry is competitive and is characterized by very strong leadership positions in specific segments of the EDA market. These strong leadership positions can be maintained for significant periods of time as the software can be difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from areas in which we are the leader. We expect to continue our strategy of developing high quality tools with number one market share potential, rather than being a broad-line supplier with undifferentiated product offerings. This strategy allows us to focus investment in areas where customer needs are greatest and where we have the opportunity to build significant market share. Our products and services are dependent to a large degree on new design projects initiated by customers in the integrated circuit (IC) and electronics system industries. These industries can be cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. Furthermore, extended economic downturns can result in reduced funding for development due to 20-------------------------------------------------------------------------------- Table Of Contents downsizing and other business restructurings. These pressures are offset by the need for the development and introduction of next generation products once an economic recovery occurs. Known Trends and Uncertainties Impacting Future Results of Operations Our revenue has historically fluctuated quarterly and has generally been the highest in the fourth quarter of our fiscal year due to our customers' corporate calendar year-end spending trends and the timing of contract renewals. Ten accounts make up approximately 30% of our receivables, including both short and long-term balances. We have not experienced and do not presently expect to experience collection issues with these customers. Net of reserves, we have no receivables greater than 60 days past due, and continue to experience no difficulty in factoring our high quality receivables. Bad debt expense recorded for the first six months of fiscal 2015 was not material. However, we do have exposures within our receivables portfolio to customers with weak credit ratings. These receivable balances do not represent a material portion of our portfolio but could have a material adverse effect on earnings in any given quarter, should significant additional allowances for doubtful accounts be necessary. Bookings during the first six months of fiscal 2015 decreased by approximately 30% compared to the first six months of fiscal 2014 primarily due to a decrease in emulation bookings. Bookings are the value of executed orders during a period for which revenue has been or will be recognized within six months for software products and within twelve months for emulation hardware systems, professional services, and training. Ten customers accounted for approximately 35% of total bookings for the first six months of fiscal 2015 compared to 65% for the first six months of fiscal 2014. The number of new customers during the first six months of fiscal 2015 increased approximately 10% from the levels experienced during the first six months of fiscal 2014. Product Development During the first six months of fiscal 2015, we continued to execute our strategy of focusing on technical challenges encountered by customers, as well as building upon our well-established product families. We believe that customers, faced with leading-edge design challenges in creating new products, generally choose the best EDA products in each category to build their design environment. Through both internal development and strategic acquisitions, we have focused on areas where we believe we can build a leading market position or extend an existing leading market position. We believe that the development and commercialization of EDA software tools is generally a three to five year process with limited customer adoption and sales in the first years of tool availability. Once tools are adopted, however, their life spans tend to be long. During the first six months of fiscal 2015, we introduced new products and upgrades to existing products and did not have any significant products reaching the end of their useful economic life. Critical Accounting Policies We base our discussion and analysis of our financial condition and results of operations upon our condensed consolidated financial statements which have been prepared in accordance with United States (U.S.) generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our estimates on an on-going basis. We base our estimates on historical experience, current facts, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs, and expenses that are not readily apparent from other sources. As future events and their effects cannot be determined with precision, actual results could differ from those estimates. We believe that the accounting for revenue recognition, valuation of trade accounts receivable, income taxes, business combinations, goodwill, intangible assets, long-lived assets, special charges, and stock-based compensation are the critical accounting estimates and judgments used in the preparation of our condensed consolidated financial statements. For further discussion of our critical accounting policies, see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in Part II of our Annual Report on Form 10-K for the year ended January 31, 2014. 21-------------------------------------------------------------------------------- Table Of Contents RESULTS OF OPERATIONS Revenues and Gross Profit Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 System and software revenues $ 149.5 - % $ 150.2 $ 297.7 9 % $ 273.5 System and software gross profit $ 131.5 (2 )% $ 134.3 $ 251.3 2 % $ 247.4 Gross profit percent 88 % 89 % 84 % 90 % Service and support revenues $ 110.7 7 % $ 103.0 $ 214.7 4 % $ 206.2 Service and support gross profit $ 79.8 8 % $ 74.1 $ 154.7 5 % $ 147.3 Gross profit percent 72 % 72 % 72 % 71 % Total revenues $ 260.2 3 % $ 253.2 $ 512.4 7 % $ 479.7 Total gross profit $ 211.3 1 % $ 208.4 $ 406.0 3 % $ 394.7 Gross profit percent 81 % 82 % 79 % 82 % System and Software Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 Upfront license revenues $ 124.9 (2 )% $ 127.6 $ 249.7 10 % $ 227.9 Ratable license revenues 24.6 9 % 22.6 48.0 5 % 45.6 Total system and software revenues $ 149.5 - % $ 150.2 $ 297.7 9 % $ 273.5 We derive system and software revenues from the sale of licenses of software products and emulation hardware systems, including finance fee revenues from our long-term installment receivables resulting from term product sales. Upfront license revenues consist of perpetual licenses and term licenses for which we recognize revenue upon product delivery at the start of a license term. We identify term licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues primarily consist of short-term term licenses and finance fees from the accretion of the discount on long-term installment receivables. Ten customers accounted for approximately 55% of system and software revenues for the three months ended July 31, 2014 and 45% for the six months ended July 31, 2014 compared to approximately 70% for the three months ended July 31, 2013 and 55% for the six months ended July 31, 2013. System and software revenues increased for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 primarily as a result of increased sales of emulation hardware systems. For the three months ended July 31, 2014, no single customer accounted for 10% or more of total revenues. For the three months ended July 31, 2013, two customers each accounted for 13% of total revenues. For the six months ended July 31, 2014, one customer accounted for 11% of total revenues. For the six months ended July 31, 2013, no single customer accounted for 10% or more of total revenues. System and software gross profit percent was lower for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 primarily due to increased sales of lower-margin emulation hardware systems. Service and Support We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which include consulting, training, and other services. Professional services are lower margin offerings which are staffed according to fluctuations in demand. Support services operate under a less variable cost structure. The increase in service and support revenues for the three and six months ended July 31, 2014 compared to the three and six months ended July 31, 2013 was primarily due to increased support revenues resulting from an increase in our installed base. 22-------------------------------------------------------------------------------- Table Of Contents Geographic Revenues Information Revenue by Geography Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 North America $ 120.8 25 % $ 96.6 $ 247.8 27 % $ 195.7 Europe 55.4 21 % 45.7 115.6 22 % 94.4 Japan 21.0 27 % 16.5 42.3 (2 )% 43.2 Pacific Rim 63.0 (33 )% 94.4 106.7 (27 )% 146.4 Total revenues $ 260.2 3 % $ 253.2 $ 512.4 7 % $ 479.7 The changes in revenues in all geographic regions for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 were primarily due to the timing of contract renewals. The changes in revenues in North America and Europe for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 were primarily due to increased sales of emulation hardware systems and the timing of contract renewals. The change in revenues in the Pacific Rim for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 was primarily due to the timing of contract renewals. We recognize additional revenues in periods when the U.S. dollar weakens in value against foreign currencies. Likewise, we recognize lower revenues in periods when the U.S. dollar strengthens in value against foreign currencies. For the three and six months ended July 31, 2014, approximately one-third of European and approximately 90% of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. Foreign currency had a nominal impact for the three months ended July 31, 2014 compared to the three months ended July 31, 2013, as the unfavorable impact of the weak Japanese yen was offset by the favorable impact of the strong euro. Foreign currency had an unfavorable impact of $1.6 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013, primarily as a result of the strengthening of the U.S. dollar against the Japanese yen, partially offset by the favorable impact of the strengthening of the euro against the U.S. dollar. For additional description of how changes in foreign exchange rates affect our condensed consolidated financial statements, see discussion in Part I, "Item 3. Quantitative and Qualitative Disclosures About Market Risk -Foreign Currency Risk." Revenue by Category We segregate revenues into five categories of similar products and services. Each category includes both product and related support revenues. Revenues for each category as a percent of total revenues are as follows (percentages rounded to the nearest 5%): Three months ended July 31, Six months ended July 31, 2014 2013 2014 2013 Revenues: IC Design to Silicon 30 % 50 % 25 % 45 % Scalable Verification 25 % 20 % 30 % 20 % Integrated System Design 25 % 20 % 25 % 25 % New & Emerging Products 10 % 5 % 10 % 5 % Services & Other 10 % 5 % 10 % 5 % Total revenues 100 % 100 % 100 % 100 % 23-------------------------------------------------------------------------------- Table Of Contents Operating Expenses Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 Research and development $ 87.5 9 % $ 80.3 $ 172.0 8 % $ 160.0 Marketing and selling 82.3 3 % 79.8 166.9 5 % 158.9 General and administration 19.5 13 % 17.2 37.2 11 % 33.5Equity in earnings of Frontline (2.0 ) 100 % (1.0 ) (3.4 ) 162 % (1.3 ) Amortization of intangible assets 2.0 25 % 1.6 3.8 19 % 3.2 Special charges 5.1 31 % 3.9 11.0 39 % 7.9 Total operating expenses $ 194.4 7 % $ 181.8 $ 387.5 7 % $ 362.2 Selected Operating Expenses as a Percentage of Total Revenues Three months ended July 31, Six months ended July 31, 2014 2013 2014 2013 Research and development 34 % 32 % 34 % 33 % Marketing and selling 32 % 32 % 33 % 33 % General and administration 7 % 7 % 7 % 7 % Total selected operating expenses 73 % 71 % 74 % 73 % Research and Development Research and development expenses increased by $7.2 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and $12.0 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The components of this increase are summarized as follows: Change Three months ended Six months ended July 31, July 31, Salaries, variable compensation, and benefits expenses $ 2.8 $ 5.1 Expenses associated with acquired businesses 3.8 6.0 Other expenses 0.6 0.9 Total change in research and development expenses $ 7.2 $ 12.0 Marketing and Selling Marketing and selling expenses increased by $2.5 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and increased by $8.0 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The components of these changes are summarized as follows: Change Three months ended Six months ended July 31, July 31,Salaries, variable compensation, and benefits expenses $ (0.3 ) $ 4.3 Expenses associated with acquired businesses 1.6 2.4 Bad debt expense (0.2 ) (1.5 ) Other expenses 1.4 2.8 Total change in marketing and selling expenses $ 2.5 $ 8.0 General and Administration General and administration expenses increased by $2.3 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and $3.6 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. 24-------------------------------------------------------------------------------- Table Of Contents Change Three months ended Six months ended July 31, July 31, Salaries, variable compensation, and benefits expenses $ 0.6 $ 0.7 Professional services 0.9 1.2 Stock compensation 0.7 1.2 Other expenses 0.1 0.5 Total change in general and administrative expenses $ 2.3 $ 3.6 We incur a substantial portion of our operating expenses outside the U.S. in various foreign currencies. We recognize additional operating expense in periods when the U.S. dollar weakens in value against foreign currencies and lower operating expenses in periods when the U.S. dollar strengthens in value against foreign currencies. We experienced unfavorable currency movements in total operating expenses of approximately $(1.7) for the three months ended July 31, 2014 compared to the three months ended July 31, 2013, and approximately $(1.2) for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The impact of these currency movements is reflected in the changes in operating expenses detailed above. Equity in Earnings of Frontline We have a 50% interest in a joint venture, Frontline P.C.B. Solutions Limited Partnership (Frontline). Frontline is owned equally by Orbotech, Ltd., an Israeli company, and us. Frontline reports on a calendar year basis; therefore we record our interest in the earnings of Frontline on a one-month lag. The following presents the summarized financial information of our 50% interest in Frontline for the three and six months ended June 30, 2014 and 2013: Three months ended June 30, Six months ended June 30, 2014 2013 2014 2013 Net income, as reported $ 2.0 $ 1.2 $ 3.5 $ 2.3 Amortization of purchased technology and other identified intangible assets - (0.2 ) (0.1 ) (1.0 ) Equity in earnings of Frontline $ 2.0 $ 1.0 $ 3.4 $ 1.3 Special Charges Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 Litigation costs $ 4.2 27 % $ 3.3 $ 8.2 58 % $ 5.2 Employee severance and related costs 0.6 - % 0.6 1.7 (37 )% 2.7 Other costs, net 0.3 - % - 1.1 - % - Total special charges $ 5.1 31 % $ 3.9 $ 11.0 39 % $ 7.9 Special charges may include expenses incurred related to certain litigation costs, employee severance, acquisitions, excess facility costs, and asset related charges. Litigation costs consist of professional service fees for services rendered, related to patent litigation involving us, Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), and Synopsys, Inc. regarding emulation technology. Employee severance and related costs include severance benefits, notice pay, and outplacement services. These rebalance charges generally represent the aggregate of numerous unrelated rebalance plans which impact several employee groups, none of which is individually material to our financial position or results of operations. We determine termination benefit amounts based on employee status, years of service, and local statutory requirements. We communicate termination benefits to the affected employees prior to the end of the quarter in which we record the charge. Provision for Income Taxes 25-------------------------------------------------------------------------------- Table Of Contents Three months ended July 31, Six months ended July 31, 2014 Change 2013 2014 Change 2013 Income tax benefit $ (1.8 ) (22 )% $ (2.3 ) $ (1.9 ) 6 % $ (1.8 ) Generally, the provision for income taxes is the result of the mix of profits and losses earned in various tax jurisdictions with a broad range of income tax rates, withholding taxes (primarily in certain foreign jurisdictions), changes in tax reserves, and the application of valuation allowances on deferred tax assets. The provision considers that a significant amount of our earnings are in certain foreign operations, including our Irish subsidiaries. Accounting guidance for interim reporting requires that we evaluate our provision for income tax expense (benefit) based on our projected results of operations for the full year, and record adjustments in each quarter. Such adjustments consider period specific items and a separate determination of tax expense for entities in our consolidated group that are projected to have losses for which no tax benefit will be recognized. Three months ended July 31, Six months ended July 31, 2014 2013 2014 2013 Effective tax rate (15 )% (11 )% (22 )% (8 )% Net period specific items benefit $ (3.2 ) $ (4.9 ) $ (3.2 ) $ (4.5 ) Effective tax rate without period specific items 12 % 12 % 14 % 13 % For the six months ended July 31, 2014, we have a 14% effective tax rate without period specific items. This current period effective tax rate differs from our effective tax rate for the six months ended July 31, 2013 due to the application of the accounting guidance for interim periods with respect to jurisdictions with projected losses before tax for which no tax benefits will be recognized and the variability in the mix of profits and losses earned in various tax jurisdictions with a broad range of income tax rates. For our full year forecast, we have projected a 10% effective tax rate. This rate is inclusive of period specific items recognized through July 31, 2014. Our projected rate differs from tax computed at the U.S. federal statutory rate of 35% primarily due to: • The benefit of lower tax rates on earnings of foreign subsidiaries; • Reduction in liabilities for uncertain tax positions; and • Forecasted utilization of net operating loss carryforwards and tax credit carryforwards for which no benefit was previously recognized. These differences are partially offset by: • Repatriation of foreign subsidiary earnings to the U.S.; • Non-deductible equity compensation expense; and • Withholding taxes. We have not provided for income taxes on the undistributed earnings of our foreign subsidiaries to the extent they are considered permanently reinvested outside of the U.S. Upon repatriation, some of these earnings may be sheltered by U.S. loss carryforwards, research and development credits and foreign tax credits, which may reduce the federal tax liability associated with any future foreign dividend. Where the earnings of our foreign subsidiaries are not treated as permanently reinvested, we have considered the impact in our provision. We are subject to income taxes in the U.S. and in numerous foreign jurisdictions. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to our historic tax obligations varies from jurisdiction to jurisdiction. In some cases it may be extended or be unlimited. Furthermore, net operating loss and tax credit carryforwards may be subject to adjustment after the expiration of the statute of limitations of the year such net operating losses and tax credits originated. Our larger jurisdictions generally provide for a statute of limitations from three to five years. For U.S. federal income tax purposes, the tax years which remain open for examination are fiscal years 2011 and forward, although net operating loss and tax credit carryforwards from all years are subject to examination and adjustment for three years following the year in which they were utilized. We are currently under examination in various jurisdictions. The examinations are in different stages and timing of their resolution is difficult to predict. The statute of limitations remains open for years on or after fiscal 2010 in Ireland. We have reserves for taxes to address potential exposures involving tax positions that are being challenged or that could be challenged by taxing authorities even though we believe that the positions we have taken are appropriate. We believe our tax reserves are adequate to cover potential liabilities. We review the tax reserves quarterly and as circumstances warrant and adjust 26-------------------------------------------------------------------------------- Table Of Contents the reserves as events occur that affect our potential liability for additional taxes. Many of these events cannot be predicted, such as clarifications of tax law by administrative or judicial means, and it is often difficult to predict the final outcome or timing of resolution of any particular tax matter. To the extent that uncertain tax positions resolve in our favor, it could have a positive impact on our effective tax rate. LIQUIDITY AND CAPITAL RESOURCES Our primary ongoing cash requirements are for product development, operating activities, capital expenditures, debt service, and acquisition opportunities that may arise. Our primary sources of liquidity are cash generated from operations and borrowings on our revolving credit facility. We currently have sufficient funds for domestic operations and do not anticipate the need to repatriate funds associated with our permanently reinvested foreign earnings for use in U.S. operations. As of July 31, 2014, we have cash totaling $159.3 held by our foreign subsidiaries. A significant portion of our offshore cash is accessible without a significant tax cost as the repatriation of foreign earnings may be sheltered from U.S. federal tax by net operating losses and tax credits. To the extent our foreign earnings are not permanently reinvested, we have provided for the tax consequences that would ensue upon their repatriation. In the event funds which are treated as permanently reinvested are repatriated, we may be required to accrue and pay additional taxes to repatriate these funds. To date, we have experienced no loss or lack of access to our invested cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets. At any point in time, we have significant balances in operating accounts that are with individual third-party financial institutions, which may exceed the Federal Deposit Insurance Corporation insurance limits or other regulatory insurance program limits. We monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate; however, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets. We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis: • Current cash balances; • Anticipated cash flows from operating activities, including the effects of selling and financing customer term receivables; • Amounts available under existing revolving credit facilities; and • Other available financing sources, such as the issuance of debt or equity securities. We have experienced no difficulties to date in raising debt. However, capital markets have been volatile, and we cannot assure that we will be able to raise debt or equity capital on acceptable terms, if at all. Cash Flow Information Six months ended July 31, 2014 2013 Cash provided by operating activities $ 38.6 $ 35.2 Cash used in investing activities $ (85.1 ) $ (21.5 ) Cash used in financing activities $ (72.7 ) $ (26.0 ) Operating Activities Cash flows from operating activities consist of our net income adjusted for certain non-cash items and changes in operating assets and liabilities. Trade Accounts and Term Receivables 27-------------------------------------------------------------------------------- Table Of Contents Our cash flows from operating activities are significantly influenced by the payment terms on our license agreements and by our sales of qualifying accounts receivable. Our customers' inability to fulfill payment obligations could adversely affect our cash flow. Though we have not, to date, experienced a material level of defaults, material payment defaults by our customers as a result of negative economic conditions or otherwise could have a material adverse effect on our financial condition. We monitor our accounts receivable portfolio for customers with low or declining credit ratings and increase our collection efforts when necessary. Trade accounts and term receivables consisted of the following: As of July 31, 2014 January 31, 2014 Trade accounts receivable, net $ 423.7 $ 454.5 Term receivables, short-term (included in trade accounts receivable on the balance sheet) $ 311.2 $ 274.7 Term receivables, long-term $ 236.7 $ 270.4 Average days sales outstanding including the short-term portion of term receivables 147 days 102 days Average days sales outstanding in trade accounts receivable, excluding the short-term portion of term receivables 39 days 40 days The increase in the average days sales outstanding in term receivables, short-term as of July 31, 2014, was primarily due to a decrease in revenue in the second quarter of fiscal 2015 compared to the fourth quarter of fiscal 2014. Term receivables are attributable to multi-year term license sales agreements. We include amounts for term agreements that are due within one year in trade accounts receivable, net, on our balance sheet and balances that are due in more than one year in term receivables, long-term. We use term agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. Total term receivables were $547.9 as of July 31, 2014 compared to $545.0 as of January 31, 2014. We enter into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. We received net proceeds from the sale of receivables of $11.4 for the six months ended July 31, 2014 compared to $9.6 for the six months ended July 31, 2013. We continue to have no difficulty in factoring receivables and continue to evaluate the economics of the sale of accounts receivable. We have not set a target for the sale of accounts receivables for the remainder of fiscal 2015. Accrued Payroll and Related Liabilities As of July 31, 2014 January 31, 2014 Accrued payroll and related liabilities $ 51.5 $ 102.8 The decrease in accrued payroll and related liabilities as of July 31, 2014 compared to January 31, 2014 was primarily due to incentive payments made during fiscal 2015 on fiscal 2014 year-end accruals. We generally experience higher accrued payroll and related liability balances at year-end primarily due to increased commission accruals associated with an increase in revenues in the fourth quarter. Additionally, we generally experience an increase in variable compensation at year-end due to the full year achievement of results. Investing Activities Cash used in investing activities for the six months ended July 31, 2014 primarily consisted of cash paid for acquisitions of businesses and capital expenditures. On March 20, 2014, we acquired for cash all of the outstanding common shares of Berkeley Design Automation, Inc. (BDA), a leader in nanometer analog, mixed signal, and radio frequency circuit verification for total consideration of $51.3, including current period cash payments of $46.8 ($45.5, net of $1.3 of acquired cash). The acquisition of BDA aligns with Mentor's goal to deliver technologies with superior performance and automation for the growing challenges of Analog/Mixed-Signal verification. During the three months ended July 31, 2014, we acquired two privately-held companies which were accounted for as business combinations for total consideration of $39.1, including current period cash payments of $33.9 ($30.4, net of $3.5 of acquired 28-------------------------------------------------------------------------------- Table Of Contents cash). We plan to finance future business acquisitions through cash and possible common stock issuances. The cash expected to be utilized includes cash on hand, cash generated from operating activities, and borrowings on our revolving credit facility. Expenditures for property, plant, and equipment were $13.3 for the six months ended July 31, 2014 compared to $13.8 for the six months ended July 31, 2013. The expenditures for property, plant, and equipment for the six months ended July 31, 2014 were primarily a result of spending on information technology and infrastructure improvements within facilities. We expect total capital expenditures for property, plant, and equipment for fiscal 2015 to be approximately $35.0. We plan to finance these capital expenditures using cash on hand. Financing Activities For the six months ended July 31, 2014, cash used in financing activities consisted primarily of repurchases of our common stock, a net decrease in short-term borrowings, and the payment of dividends. In April 2014, our previous three-year share repurchase program expired. On June 12, 2014, we announced a new share repurchase program approved by our Board of Directors, authorizing the repurchase of up to $200 million of our common stock over a three-year period. During the six months ended July 31, 2014, we repurchased 3.2 shares of common stock for $70.1 under these programs. As of July 31, 2014, $175.0 remained available for purchase under the program approved in June 2014. During the six months ended July 31, 2014, we paid two quarterly dividends of $0.05 per share of outstanding common stock for a total of $11.5. On August 21, 2014, we announced a quarterly dividend of $0.05 per share of outstanding common stock, payable on September 30, 2014 to shareholders of record as of the close of business on September 10, 2014. Future declarations of quarterly dividends and the establishment of future record and payment dates are subject to the quarterly determination of our Board of Directors. The terms of our revolving credit facility limit the combination of the amount of our common stock we can repurchase and the amount of dividends we can pay to $50.0 plus 70% of our cumulative net income for periods after January 31, 2011. An additional $71.8 is available for common stock purchases or dividend payments under this limit as of July 31, 2014. Other factors affecting liquidity and capital resources 4.00% Convertible Subordinated Debentures due 2031 In April 2011, we issued $253.0 of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures). Interest on the 4.00% Debentures is payable semi-annually in April and October. As of July 31, 2014, each one thousand dollars in principal amount of the 4.00% Debentures is convertible, under certain circumstances, into 49.365 shares of our common stock (equivalent to a conversion price of $20.26 per share) for a total of 12.5 shares. These circumstances include: • The market price of our common stock exceeding 120% of the conversion price, or $24.31 per share as of July 31, 2014, for at least 20 of the last 30 trading days in the previous fiscal quarter; • A call for redemption of the 4.00% Debentures; • Specified distributions to holders of our common stock; • If a fundamental change, such as a change of control, occurs; • During the two months prior to, but not on, the maturity date; or • The market price of the 4.00% Debentures declining to less than 98% of the value of the common stock into which the 4.00% Debentures are convertible. Upon conversion of any 4.00% Debentures, a holder will receive: (i) Cash for the lesser of the principal amount of the 4.00% Debentures that are converted or the value of the converted shares; and (ii) Cash or shares of common stock, at our election, for the excess, if any, of the value of the converted shares over the principal amount. 29-------------------------------------------------------------------------------- Table Of Contents If a holder elects to convert their 4.00% Debentures in connection with a fundamental change in the company that occurs prior to April 5, 2016, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances. As the result of us declaring cash dividends during the fiscal year ended January 31, 2014 and the six months ended July 31, 2014, the initial conversion rate for the 4.00% Debentures of 48.6902 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.54 per share of our common stock) has been adjusted to 49.365 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.26 per share of our common stock). We may redeem some or all of the 4.00% Debentures for cash on or after April 5, 2016 at the following redemption prices expressed as a percentage of principal, plus any accrued and unpaid interest: Period Redemption Price Beginning on April 5, 2016 and ending on March 31, 2017 101.143 % Beginning on April 1, 2017 and ending on March 31, 2018 100.571 % On April 1, 2018 and thereafter 100.000 % The holders, at their option, may redeem the 4.00% Debentures in whole or in part for cash on April 1, 2018, April 1, 2021, and April 1, 2026, and in the event of a fundamental change in the company. In each case, the repurchase price will be 100% of the principal amount of the 4.00% Debentures plus any accrued and unpaid interest. For further information on the 4.00% Debentures, see Note 7. "Notes Payable" in Part I, Item 1. "Financial Statements." Revolving Credit Facility We have a revolving credit facility with a maximum borrowing capacity of $125.0, which expires on May 24, 2017. We have the option to pay interest based on: (i) London Interbank Offered Rate (LIBOR) with varying maturities commensurate with the borrowing period we select, plus a spread of between 2.00% and 2.50% based on a pricing grid tied to a financial covenant; or (ii) A base rate plus a spread of between 1.00% and 1.50%, based on a pricing grid tied to a financial covenant. As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.30% and 0.40% based on a pricing grid tied to a financial covenant. We had no borrowings against the revolving credit facility during the six months ended July 31, 2014 and 2013. This revolving credit facility contains certain financial and other covenants, including a limit on the aggregate amount we can pay for dividends and repurchases of our stock over the term of the facility. We were in compliance with all financial covenants as of July 31, 2014. If we fail to comply with the financial covenants and do not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility. For further information on our revolving credit facility, see Note 6. "Short-Term Borrowings" in Part I, Item 1. "Financial Statements." OUTLOOK FOR FISCAL 2015 We expect revenues for the third quarter of fiscal 2015 to be approximately $275.0 with earnings per share for the same period of approximately $0.07 per diluted share. For the full fiscal year 2015, we expect revenues of approximately $1.237 billion with earnings per share of $1.37 per diluted share. 30-------------------------------------------------------------------------------- Table Of Contents |