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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-19807
----------------
SYNOPSYS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1546236
------------------------------ ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
700 EAST MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(Address of principal executive offices)
TELEPHONE: (650) 584-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13, or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
75,639,019 shares of Common Stock as of September 6, 2002
SYNOPSYS, INC.
QUARTERLY REPORT ON FORM 10-Q
JULY 31, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.................................................3
CONDENSED CONSOLIDATED BALANCE SHEETS................................3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS............4
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS.........................................................5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.........................................18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK...........38
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...................................................39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS..................44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................45
SIGNATURES....................................................................45
2
PART I
ITEM 1. FINANCIAL STATEMENTS
SYNOPSYS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
JULY 31, OCTOBER 31,
2002 2001
---------------- -----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 347,661 $ 271,696
Short-term investments 98,547 204,740
---------------- -----------------
Total cash and short-term investments 446,208 476,436
Accounts receivable, net of allowances of $22,985 and
$11,027, respectively 233,157 146,294
Deferred tax assets 169,208 149,239
Prepaid expenses and other 54,973 19,413
---------------- -----------------
Total current assets 903,546 791,382
Property and equipment, net 185,872 192,304
Long-term investments 48,767 61,699
Goodwill, net 368,068 35,077
Intangible assets, net 351,249 3,197
Restricted asset 240,000 --
Other assets 61,503 45,248
---------------- -----------------
Total assets $ 2,159,005 $ 1,128,907
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 233,756 $ 135,272
Current portion of long-term debt 178 535
Accrued income taxes 123,338 110,561
Deferred revenue 379,897 290,052
---------------- -----------------
Total current liabilities 737,169 536,420
Deferred compensation and other long-term liabilities 50,400 17,124
Long-term deferred revenue 63,167 89,707
Stockholders' equity:
Preferred stock, $.01 par value; 2,000 shares authorized; no shares
outstanding -- --
Common stock, $.01 par value; 400,000 shares authorized; 76,105 and
59,428 shares outstanding, respectively 761 595
Additional paid-in capital 1,031,183 575,403
Retained earnings 303,755 436,662
Treasury stock, at cost (9,875) (531,117)
Deferred stock compensation (7,592) --
Accumulated other comprehensive income (9,963) 4,113
---------------- -----------------
Total stockholders' equity 1,308,269 485,656
---------------- -----------------
Total liabilities and stockholders' equity $ 2,159,005 $ 1,128,907
================ =================
The accompanying notes are an integral part of these financial statements.
3
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
2002 2001 2002 2001
----------------- ----------------- ----------------- -----------------
Revenue:
Product $ 60,096 $ 44,858 $ 151,944 $ 117,152
Service 73,924 81,430 208,782 259,900
Ratable license 102,075 49,822 236,552 119,736
----------------- ----------------- ----------------- -----------------
Total revenue 236,095 176,110 597,278 496,788
----------------- ----------------- ----------------- -----------------
Cost of revenue:
Product 4,400 6,086 11,687 17,616
Service 19,819 19,158 57,894 58,427
Ratable license 10,101 7,476 34,321 19,689
Amortization of intangible assets and
deferred stock compensation 13,366 - 13,366 -
----------------- ----------------- ----------------- -----------------
Total cost of revenue 47,686 32,720 117,268 95,732
----------------- ----------------- ----------------- -----------------
Gross margin 188,409 143,390 480,010 401,056
Operating expenses:
Research and development 61,581 49,382 156,936 143,239
Sales and marketing 69,122 68,954 192,122 207,735
General and administrative 21,908 19,140 58,153 50,933
Integration 117,266 - 117,266 -
In-process research and development 82,500 - 82,500 -
Amortization of intangible assets and deferred stock
compensation 8,820 4,163 17,220 12,514
----------------- ----------------- ----------------- -----------------
Total operating expenses 361,197 141,639 624,197 414,421
----------------- ----------------- ----------------- -----------------
Operating (loss) income (172,788) 1,751 (144,187) (13,365)
Other income, net 11,408 19,499 33,702 66,901
----------------- ----------------- ----------------- -----------------
(Loss) income before (benefit) provision for income (161,380) 21,250 (110,485) 53,536
taxes
(Benefit) provision for income taxes (23,791) 6,800 (8,328) 17,132
----------------- ----------------- ----------------- -----------------
Net (loss) income $ (137,589) $ 14,450 $ (102,157) $ 36,404
================= ================= ================= =================
Basic (loss) earnings per share $ (1.93) $ 0.24 $ (1.59) $ 0.60
================= ================= ================= =================
Weighted average common shares outstanding 71,157 60,048 64,157 61,050
================= ================= ================= =================
Diluted (loss) earnings per share $ (1.93) $ 0.22 $ (1.59) $ 0.56
================= ================= ================= =================
Weighted average common shares
and dilutive stock options outstanding 71,157 64,887 64,157 65,362
================= ================= ================= =================
The accompanying notes are an integral part of these financial statements.
4
SYNOPSYS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
NINE MONTHS ENDED
JULY 31,
----------------------------------
2002 2001
---------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (102,157) $ 36,404
Adjustments to reconcile net (loss) income to net cash flows (used in)
provided by operating activities:
In-process research and development 82,500 --
Depreciation and amortization 69,835 48,149
Tax benefit associated with stock options 18,001 14,603
Impairment of land and buildings 14,712 --
Impairment of long-term investments 7,539 4,348
Provision for doubtful accounts and sales returns 3,065 2,237
Deferred taxes (3,967) --
Gain on sale of long-term investments (21,393) (43,128)
Gain on sale of silicon libraries business -- (10,580)
Other 2,538 306
Net changes in operating assets and liabilities:
Accounts receivable (22,774) 12,491
Prepaid expenses and other current assets 1,079 (2,366)
Other assets (7,323) (414)
Accounts payable and accrued liabilities (75,978) (22,008)
Accrued income taxes (81,799) (19,614)
Deferred revenue 33,225 100,153
Deferred compensation 4,748 2,781
---------------- -----------------
Net cash (used in) provided by operating activities (78,149) 123,362
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of contingently refundable insurance policy (240,000) --
Cash acquired in the Avant! acquisition 234,963 --
Purchases of property and equipment (35,902) (51,980)
Purchases of short-term investments (667,430) (1,656,744)
Proceeds from sales and maturities of short-term investments 778,501 1,764,892
Purchases of long-term investments (5,205) (11,000)
Proceeds from sale of long-term investments 30,533 62,446
Proceeds from the sale of silicon libraries business -- 4,122
Purchase of intangible assets, net -- (166)
Capitalization of software development costs (1,194) (750)
---------------- -----------------
Net cash provided by investing activities 94,266 110,820
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of debt obligations -- (6,468)
Issuances of common stock 103,595 89,310
Purchases of treasury stock (41,773) (331,878)
---------------- -----------------
Net cash provided by (used in) financing activities 61,822 (249,036)
Effect of exchange rate changes on cash (1,974) (3,762)
---------------- -----------------
Net increase (decrease) in cash and cash equivalents 75,965 (18,616)
Cash and cash equivalents, beginning of period 271,696 153,120
---------------- -----------------
Cash and cash equivalents, end of period $ 347,661 $ 134,504
================ =================
SUPPLEMENTAL NONCASH DISCLOSURES:
Issuance of stock and options in exchange for net assets of Avant! $ 858,421 $ --
The accompanying notes are an integral part of these financial statements.
5
SYNOPSYS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF COMPANY AND BASIS OF PRESENTATION
Synopsys, Inc. (Synopsys or the Company) is a leading supplier of electronic
design automation (EDA) software to the global electronics industry. The Company
develops, markets, and supports a wide range of integrated circuit (IC) design
products that are used by designers of advanced ICs and the electronic systems
(such as computers, cell phones, and internet routers) that use such ICs to
automate significant portions of their IC design process. ICs are distinguished
by the speed at which they run, their area, the amount of power they consume and
their cost of production. Synopsys' products offer its customers the opportunity
to design ICs that are optimized for speed, area, power consumption and
production cost, while reducing overall design time. The Company also provides
consulting services to help its customers improve their IC design processes and
to assist them with their IC designs, as well as training and support services.
The Company's fiscal year ends on the Saturday nearest October 31. Fiscal
year 2001 was a 53-week year, with the extra week added to the first quarter,
and fiscal year 2002 will be a 52-week year. For presentation purposes, the
unaudited condensed consolidated financial statements and notes refer to the
calendar month end.
On June 6, 2002 (the "closing date"), the Company completed its merger with
Avant! Corporation (Avant!), a company that develops, markets, licenses and
supports electronic design automation software products that assist design
engineers in the physical layout, design, verification, simulation, timing and
analysis of advanced integrated circuits. Under the terms of the merger
agreement between the Company and Avant!, Avant! merged with and into a wholly
owned subsidiary of Synopsys. The merger is accounted for under the purchase
method of accounting. The results of operations of Avant! are included in the
accompanying condensed consolidated financial statements for the period from the
closing date through July 31, 2002.
The unaudited condensed consolidated financial statements include the
accounts of Synopsys and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated. In the opinion of
management, all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the financial position and results of
operations of the Company have been made. Operating results for the interim
periods are not necessarily indicative of the results that may be expected for
any future period or the full fiscal year. The unaudited condensed consolidated
financial statements and notes included herein should be read in conjunction
with the consolidated financial statements and notes thereto for the fiscal year
ended October 31, 2001 included in the Company's 2001 Annual Report on Form
10-K.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the unaudited condensed
consolidated financial statements and accompanying notes. A change in the facts
and circumstances surrounding these estimates and assumptions could result in a
change to the estimates and assumptions and impact future operating results.
2. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION AND COST OF REVENUE
Revenue consists of fees for perpetual and time-based licenses for the
Company's software products, sales of hardware system products, post-contract
customer support (PCS), customer training and consulting. The Company classifies
its revenues as product, service or ratable license. Product revenue consists
primarily of sales of perpetual licenses.
Service revenue consists of fees for consulting services, training, and PCS
associated with non-ratable time-based licenses or perpetual licenses. PCS sold
with perpetual licenses is generally renewable, after any bundled PCS period
expires, in one-year increments for a fixed percentage of the perpetual list
price or, for perpetual license arrangements in excess of $2 million, as a
percentage of the net license fee.
Ratable license revenue is all fees related to time-based licenses bundled
with PCS and sold as a single package (commonly referred to by the Company as a
Technology Subscription License or TSL), and time-based licenses on which the
Company has granted extended payment terms or under which the customer has a
right to receive unspecified future products.
6
Cost of product revenue includes cost of production personnel, product
packaging, documentation, amortization of capitalized software development
costs, and costs of the Company's systems products. Cost of service revenue
includes personnel and the related costs associated with providing training,
consulting and PCS. Cost of ratable license revenue includes the cost of
products and services related to time-based licenses bundled with PCS and sold
as a single package and to time-based licenses that include extended payment
terms or unspecified additional products. Cost of revenue also includes the
amortization of the contract rights intangible, core technology and deferred
compensation.
The Company recognizes revenue in accordance with SOP 97-2, SOFTWARE REVENUE
RECOGNITION, as amended by SOP 98-9 and SOP 98-4, and generally recognizes
revenue when all of the following criteria are met as set forth in paragraph 8
of SOP 97-2:
o Persuasive evidence of an arrangement exists,
o Delivery has occurred,
o The vendor's fee is fixed or determinable, and
o Collectibility is probable.
The Company defines each of the four criteria above as follows:
PERSUASIVE EVIDENCE OF AN ARRANGEMENT EXISTS. It is the Company's customary
practice to have a written contract, which is signed by both the customer
and Synopsys, or a purchase order from those customers that have previously
negotiated a standard end-user license arrangement or volume purchase
agreement, prior to recognizing revenue on an arrangement.
DELIVERY HAS OCCURRED. The Company's software may be either physically or
electronically delivered to its customers. For those products that are
delivered physically, the Company's standard transfer terms are FOB shipping
point. For an electronic delivery of software, delivery is considered to
have occurred when the customer has been provided with the access codes that
allow the customer to take immediate possession of the software on its
hardware.
If an arrangement includes undelivered products or services that are
essential to the functionality of the delivered product, delivery is not
considered to have occurred.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. The fee the Company's customers
pay for its products is negotiated at the outset of an arrangement, and is
generally based on the specific volume of products to be delivered. The
Company's license fees are not a function of variable-pricing mechanisms
such as the number of units distributed or copied by the customer, or the
expected number of users in an arrangement. Therefore, except in cases where
the Company grants extended payment terms to a specific customer, the
Company's fees are considered to be fixed or determinable at the inception
of its arrangements.
The Company's customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. Arrangements with payment
terms extending beyond the customary payment terms are considered not to be
fixed or determinable. Revenue from such arrangements is recognized at the
lesser of the aggregate of amounts due and payable or the amount of the
arrangement fee that would have been recognized if the fees had been fixed
or determinable.
COLLECTIBILITY IS PROBABLE. Collectibility is assessed on a
customer-by-customer basis. The Company typically sells to customers for
which there is a history of successful collection. New customers are
subjected to a credit review process, which evaluates the customers'
financial positions and, ultimately, their ability to pay. New customers are
typically assigned a credit limit based on a formulated review of their
financial position. Such credit limits are only increased after a successful
collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not
probable based upon the Company's credit review process, revenue is
recognized on a cash-collected basis.
MULTIPLE-ELEMENT ARRANGEMENTS. The Company allocates revenue on software
arrangements involving multiple elements to each element based on the relative
fair values of the elements. The Company's determination of fair value of each
element in multiple-element arrangements is based on vendor-specific objective
evidence (VSOE). The Company limits its assessment of VSOE for each element to
the price charged when the same element is sold separately.
7
The Company has analyzed all of the elements included in its
multiple-element arrangements and determined that it has sufficient VSOE to
allocate revenue to the PCS components of its perpetual license products and
consulting. Accordingly, assuming all other revenue recognition criteria are
met, revenue from perpetual licenses is recognized upon delivery using the
residual method in accordance with SOP 98-9, and revenue from PCS is recognized
ratably over the PCS term. The Company recognizes revenue from TSLs over the
term of the ratable license period, as the license and PCS portions of a TSL are
bundled and not sold separately. Revenue from contracts with extended payment
terms is recognized as the lesser of amounts due and payable or the amount of
the arrangement fee that would have been recognized if the fee were fixed or
determinable.
Certain of the Company's time-based licenses include the rights to
unspecified additional products. Revenue from contracts with the rights to
unspecified additional software products is recognized ratably over the contract
term. The Company recognizes revenue from time-based licenses that include both
unspecified additional software products and extended payment terms that are not
considered to be fixed or determinable in an amount that is the lesser of
amounts due and payable or the ratable portion of the entire fee.
CONSULTING SERVICES. The Company provides design methodology assistance,
specialized services relating to telecommunication systems design and turnkey
design services. The Company's consulting services generally are not essential
to the functionality of the software. The Company's software products are fully
functional upon delivery and implementation does not require any significant
modification or alteration. The Company's services to its customers often
include assistance with product adoption and integration and specialized design
methodology assistance. Customers typically purchase these professional services
to facilitate the adoption of the Company's technology and dedicate personnel to
participate in the services being performed, but they may also decide to use
their own resources or appoint other professional service organizations to
provide these services. Software products are billed separately and
independently from consulting services, which are generally billed on a
time-and-materials or milestone-achieved basis. The Company generally recognizes
revenue from consulting services as the services are performed.
Exceptions to the general rule above involve arrangements where the Company
has committed to significantly alter the features and functionality of its
software or build complex interfaces necessary for the Company's software to
function in the customer's environment. These types of services are considered
to be essential to the functionality of the software. Accordingly, contract
accounting is applied to both the software and service elements included in
these arrangements.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, BUSINESS COMBINATIONS
(SFAS 141), and No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS (SFAS 142). SFAS
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and specifies criteria intangible
assets acquired in a purchase method business combination must meet to be
recognized apart from goodwill. SFAS 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested for impairment at least annually in accordance with the provisions of
SFAS 142.
The Company adopted the provisions of SFAS 141 on July 1, 2001. Under SFAS
141, goodwill and intangible assets with indefinite useful lives acquired in a
purchase business combination completed after June 30, 2001, but before SFAS 142
is adopted, will not be amortized but will continue to be evaluated for
impairment in accordance with SFAS 121. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized and tested for impairment in accordance with current accounting
guidance until the date of adoption of SFAS 142.
Upon adoption of SFAS 142, the Company must evaluate its existing intangible
assets and goodwill acquired in purchase business combinations prior to July 1,
2001, and make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, the Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments. The Company will also be required to test goodwill for
impairment in accordance with the provisions of SFAS 142 within the six-month
period following adoption. Any impairment loss will be measured as of the date
of adoption and recognized immediately as the cumulative effect of a change in
accounting principle. Any subsequent impairment losses will be included in
operating activities.
The Company expects to adopt SFAS 142 on November 1, 2002. As of July 31,
2002, unamortized goodwill of $23.1 million will continue to be amortized until
the date of adoption of SFAS 142, in accordance with the Statements.
8
Amortization of goodwill and other intangible assets for the nine-month period
ended July 31, 2002 is $12.1 million. Goodwill totaling $344.9 relates to
acquisitions subsequent to July 1, 2001 and is therefore not amortized in
accordance with SFAS 142. The Company does not have any intangible assets with
an indefinite useful life. The Company is currently evaluating the impact of the
adoption of this statement on its financial position and results of operations.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS (SFAS 143). SFAS 143
requires that asset retirement obligations that are identifiable upon
acquisition, construction or development and during the operating life of a
long-lived asset be recorded as a liability using the present value of the
estimated cash flows. A corresponding amount would be capitalized as part of the
asset's carrying amount and amortized to expense over the asset's useful life.
The Company is required to adopt the provisions of SFAS 143 effective November
1, 2002. The adoption of SFAS 143 will not have a significant impact on the
Company's financial position and results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS (SFAS
144), which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and
the accounting and reporting provisions of APB Opinion No. 30, REPORTING THE
RESULTS OF OPERATIONS FOR A DISPOSAL OF A SEGMENT OF A BUSINESS. The Company is
required to adopt the provisions of SFAS 144 no later than November 1, 2002. The
Company does not expect that the adoption of SFAS 144 will have a significant
impact on its financial position and results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS (SFAS 145). SFAS 145 eliminates the
requirement that gains and losses from the extinguishments of debt be aggregated
and, if material, classified as an extraordinary item, net of the related income
tax effect. However, an entity would not be prohibited from classifying such
gains and losses as extraordinary items so long as they are both unusual in
nature and infrequent in occurrence. The Company is required to adopt the
provisions of SFAS 145 effective November 1, 2002. SFAS 145 also amends SFAS 13,
ACCOUNTING FOR LEASES and certain other authoritative pronouncements to make
technical corrections or clarifications. SFAS 145 is effective related to the
amendment of SFAS 13 for all transactions occurring after May 15, 2002. The
Company does not expect that the adoption of SFAS 145 will have a significant
impact on its financial position and results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES. SFAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING) and requires liabilities associated with exit and disposal
activities to be expensed as incurred. SFAS 146 will be effective for exit or
disposal activities of the Company that are initiated after December 31, 2002.
The Company is evaluating the effect of adopting SFAS 146 on its financial
position and results of operations.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to current year
presentation.
3. ACQUISITION OF AVANT! CORPORATION
On June 6, 2002 (the "closing date"), the Company completed the merger with
Avant! Corporation (Avant!).
REASONS FOR THE ACQUISITION. The Company's Board of Directors unanimously
approved the Company's merger with Avant! at its December 1, 2001 meeting. In
approving the merger agreement, the Board of Directors consulted with legal and
financial advisors as well as with management and considered a number of
factors. Management is willing to pay a premium over the fair value of the
tangible and identifiable intangible assets as the merger is expected to enable
Synopsys to offer its customers a complete end-to-end solution for IC design
that combines Synopsys' logic synthesis and design verification tools with
Avant!'s advanced place and route, physical verification and design integrity
products, thus increasing customers' design efficiencies. By increasing customer
9
design efficiencies, Synopsys expects to be able to better compete for customers
designing the next generation of semiconductors. Further, by gaining access to
Avant!'s physical design and verification products, as well as its broad
customer base and relationships, Synopsys will gain new opportunities to market
its existing products. The foregoing discussion of the information and factors
considered by the Company's Board of Directors is not intended to be exhaustive
but includes the material factors considered by the Company's Board.
PURCHASE PRICE. Holders of Avant! common stock received 0.371 of a share of
Synopsys common stock (including the associated preferred stock rights) in
exchange for each share of Avant! common stock owned as of the closing date,
aggregating 14.5 million shares of Synopsys common stock. The fair value of the
Synopsys shares issued was based on a per share value of $54.74, which is equal
to Synopsys' average last sale price per share as reported on the Nasdaq
National Market for the trading-day period two days before and after December 3,
2001, the date of the merger agreement.
The total purchase consideration consists of the following:
(IN THOUSANDS)
Fair value of Synopsys common stock issued $ 795,388
Estimated acquisition related costs 37,342
Estimated facilities closure costs 62,638
Estimated employee severance costs 50,367
Estimated fair value of options to purchase Synopsys common stock to
be issued, less $8.1 million representing the portion of the
intrinsic value of Avant!'s unvested options applicable to the
remaining vesting period 63,033
-----------------
$ 1,008,768
=================
The estimated acquisition-related costs of $37.3 million consist primarily
of banking, legal and accounting fees, printing costs, and other directly
related charges including contract termination costs of $6.7 million. The
Company is currently reviewing all outstanding Avant! contracts to determine the
additional cost, if any, to exit existing contracts which may result in
additional accruals for contract termination costs in accordance with Emerging
Issues Task Force (EITF) Issue No. 95-3. Any such accruals would increase the
purchase consideration and the allocation of the purchase consideration to
goodwill.
Estimated facilities closure costs includes $54.2 million related to
Avant!'s corporate headquarters. The lessor has brought a claim against the
Company for the future amounts payable under the lease agreements. The amount
accrued at the closing date is equal to the future amounts payable under the
related lease agreements, without taking into consideration in the accrual any
defenses we may have to the claim. Resolution of this contingency at an amount
different from that accrued will result in an increase or decrease in the
purchase consideration and the amount allocated to goodwill. The remaining
estimated facilities closure costs totaling $8.4 million represents the present
value of the future obligations under certain of Avant!'s lease agreements which
the Company has or intends to terminate under an approved facilities exit plan
plus additional costs expected to be incurred directly related to vacating such
facilities.
Estimated employee severance costs include (i) $39.6 million in cash paid to
Avant!'s Chairman of the Board, consisting of severance plus a cash payment
equal to the intrinsic value of his in-the-money stock options at the closing
date, (ii) $4.5 million in cash severance payments paid to redundant employees
(primarily sales and corporate infrastructure personnel) terminated on or
subsequent to the consummation of the merger under an approved plan of
termination and (iii) $6.3 million in termination payments to certain executives
in accordance with their respective pre-merger employment agreements. The total
number of Avant! employees expected to be terminated as a result of the merger
is approximately 250.
10
As of July 31, 2002, $73.3 million of costs described in the three preceding
paragraphs have been paid and $77.1 million of these costs have not yet been
paid. The following table presents the components of acquisition-related costs
recorded, along with amounts paid through the third quarter of 2002.
Payments
Total Cost through Balance at
(IN THOUSANDS) July 31, 2002 July 31, 2002
------------ ---------------- ----------------
Estimated acquisition related costs $ 37,342 $23,967 $13,375
Estimated facilities closure costs 62,638 262 62,376
Estimated employee severance costs 50,367 49,031 1,336
------------ ---------------- ----------------
Total $150,347 $73,260 $77,087
============ ================ ================
The total purchase consideration has been allocated on a preliminary basis
to the assets and liabilities acquired, including identifiable intangible
assets, based on their respective fair value at the acquisition date and
resulted in excess purchase consideration over the net tangible and identifiable
intangible assets acquired of $344.9 million. The following unaudited condensed
balance sheet data presents the preliminary fair value of the assets and
liabilities acquired and recorded at June 6, 2002.
(IN THOUSANDS)
Assets acquired
Cash, cash equivalents and short-term investments $ 241,313
Accounts receivable 67,154
Prepaid expenses and other current assets 19,483
Assets held for sale 33,220
Intangible assets 365,000
Goodwill 344,949
Other assets 3,876
----------------
Total assets acquired $ 1,074,995
================
Liabilities acquired
Accounts payable and accrued liabilities $ 172,528
Deferred revenue 30,080
Income taxes payable 94,576
Other liabilities 4,651
----------------
Total liabilities acquired $ 301,835
================
Other current assets acquired includes an investment in a venture-capital
fund valued at $12.8 million. Management intends to dispose of this investment;
however, the Company has been unable to obtain certain financial records and
information required to effectively market the investment. The fair value of the
asset recorded does not include any adjustment of this investment due to this
contingency. Any adjustment to the fair-value of this investment which is
ultimately made will increase or decrease the purchase consideration and the
allocation of the purchase consideration to goodwill.
11
UNAUDITED PRO FORMA RESULTS OF OPERATIONS. The following table presents pro
forma results of operations and gives effect to the proposed merger as if the
merger had been consummated on November 1, 2000. The unaudited pro forma results
of operations are not necessarily indicative of the results of operations had
the acquisition actually occurred at the beginning of fiscal 2001, nor is it
necessarily indicative of future operating results:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
-------------- -------------- ------------ ------------
Revenues $ 278,217 $ 276,922 $ 861,822 $ 789,308
Net income (loss) 16,099 18,434 71,697 (188,593)
Basic earnings (loss) per share $ 0.23 $ 0.25 $ 1.12 $ (2.50)
Weighted average common shares outstanding 71,157 74,578 64,157 75,580
Diluted earnings (loss) per share $ 0.21 $ 0.23 $ 1.04 $ (2.50)
Weighted average common shares and dilutive stock
options outstanding 71,157 80,351 64,157 75,580
The unaudited pro forma results of operations for each of the periods
presented exclude non-recurring merger costs of $95,000 and $82,500 for the
contingently refundable insurance policy and IPRD recorded by Synopsys in the
third quarter of 2002 and included in the historical condensed consolidated
statement of operations.
GOODWILL AND INTANGIBLE ASSETS. Goodwill, representing the excess of the
purchase price over the fair value of tangible and identifiable intangible
assets acquired in the merger will not be amortized consistent with the guidance
with SFAS 142. The goodwill associated with the Avant! acquisition is not
deductible for tax purposes. In addition, a portion of the purchase price was
allocated to the following identifiable intangible assets:
Intangible Asset (IN THOUSANDS) Estimated Useful Life
- ------------------------------------- ----------------- ------------------------
Core/developed technology $184,000 3 years
Contract rights intangible 51,700 3 years
Customer installed base/relationship 102,500 6 years
Trademarks and tradenames 17,700 3 years
Covenants not to compete 9,100 The life of the related
agreement (2 to 4 years)
----------------
Total $365,000
================
CONTRACT RIGHTS INTANGIBLE. Avant! had executed signed license agreements,
had delivered the initial configuration of licensed technologies under ratable
license arrangements and had executed signed contracts to provide PCS over a one
to three year period, for which Avant! did not consider the fees to be fixed and
determinable at the outset of the arrangement. There were no receivables or
deferred revenues recorded on Avant!'s historical financial statements at the
closing date as the related payments were not yet due under extended payment
terms and deliveries are scheduled to occur over the term of the arrangements.
These ratable licenses and PCS arrangements require future performance by both
parties and, as such, represent executory contracts. The contract rights
intangible asset associated with these arrangements is amortized to cost of
revenues over the related contract lives.
The amortization of intangible assets, with the exception of the contract
rights intangible and the core/developed technology, is included in operating
expenses in the statement of operations for the three- and nine-month periods
ended July 31, 2002. Amortization of the core/developed technology and contract
rights intangible is included in cost of revenue.
ASSET HELD FOR SALE. In January 2001, Synopsys sold the assets of its
silicon libraries business to Artisan Components, Inc. ("Artisan") and entered
into an agreement not to engage, directly or indirectly, in the physical
libraries business before January 3, 2003. Synopsys also agreed that if it
acquired a physical libraries business as part of a larger acquisition, then
Artisan would have certain preferential rights to negotiate and bid for such
business. Prior to the merger, Avant! engaged in the physical libraries
business. As a result of the merger, Synopsys acquired Avant!'s physical
libraries business, and Synopsys is obligated to offer and sell such business to
Artisan under the terms of the January 2001 agreement. The value allocated to
the acquired libraries business was recorded as net assets held for sale and is
based on the estimated future net cash flows from the libraries business in
accordance with EITF 87-11, ALLOCATION OF PURCHASE PRICE TO ASSETS TO BE SOLD.
The carrying value of the libraries business as of July 31, 2002 is
approximately $33.1 million and losses for the period from June 6, 2002 through
July 31, 2002 that have been excluded from the consolidated income statement
were approximately $0.5 million.
12
CONTINGENTLY REFUNDABLE INSURANCE POLICY. Avant!, which upon completion of
the Synopsys-Avant! merger became a wholly-owned subsidiary of Synopsys is a
party to a number of material civil litigation matters, including civil
litigation (the Avant!/Cadence litigation) brought by Cadence Design Systems,
Inc. (Cadence) as discussed in Footnote 12. Synopsys obtained an insurance
policy from a subsidiary of American International Group, Inc., a AAA-rated
insurance company, whereby insurance was obtained for certain compensatory,
exemplary and punitive damages, penalties and fines and attorneys' fees arising
out of the Avant!/Cadence litigation. The policy does not provide coverage for
litigation other than the Avant!/Cadence litigation.
The Company paid a total premium of $335 million for the policy, of which
$240 million is contingently refundable. Under the policy the insurer is
obligated to pay covered loss up to a limit of liability equaling (a) $500
million plus (b) interest accruing at the fixed rate of 2%, compounded
semi-annually, on $250 million (the "interest component"), as reduced by
previous covered losses. The policy will expire following a final judgment or
settlement of the Avant!/Cadence litigation or any earlier date upon Synopsys'
election. Upon such expiration, Synopsys will be entitled to a payment equal to
$240 million plus the interest component less any covered loss (which, for this
purpose, shall include legal fees only to the extent that the aggregate amount
of such fees exceeds $10 million).
The contingently refundable portion of the insurance premium ($240 million)
is included in the July 31, 2002 balance sheet as a long-term restricted asset.
Interest earned on $250 million will be included in other income, net in the
post-merger statement of operations. The balance of the premium paid to the
insurer ($95 million) is included in integration expense for the three- and
nine-month periods ended July 31, 2002.
At the closing date, the Avant!/Cadence litigation was accounted for as a
pre-merger contingency because a litigation judgment or settlement amount, if
any, is not probable or estimable. If a litigation loss becomes probable and
estimable, such loss will be included in net income.
VALUATION OF IPRD. The amounts allocated to purchased research and
development, totaling $82.5 million, were determined through established
valuation techniques in the high-technology industry and were expensed upon
acquisition because technological feasibility had not been established and no
future alternative uses existed. Research and development costs to bring the
products to technological feasibility are expected to total approximately $17.5
million.
4. STOCK REPURCHASE PROGRAM
In July 2001, the Company's Board of Directors authorized a stock repurchase
program under which Synopsys common stock with a market value up to $500 million
may be acquired in the open market. This stock repurchase program replaced all
prior repurchase programs authorized by the Board. Common shares repurchased are
intended to be used for ongoing stock issuances under the Company's employee
stock plans, for acquisitions and for other corporate purposes. The July 2001
stock repurchase program expires on October 31, 2002. During the three-month and
nine-month periods ended July 31, 2001, the Company purchased 2.4 million and
6.6 million shares, respectively, of Synopsys common stock in the open market
under a prior stock repurchase program, at average prices of $53 per share and
$50 per share, respectively. The Company repurchased 0.8 million shares during
the three-month and nine-month periods ended July 31, 2002 at an average price
of $50 per share. At July 31, 2002, approximately $440.1 million remained
available for repurchases under the July 2001 program.
5. COMPREHENSIVE (LOSS) INCOME
The following table sets forth the components of comprehensive (loss)
income, net of income tax expense:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
---------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ----------------- ----------------- ----------------
(IN THOUSANDS)
Net (loss) income $(137,589) $ 14,450 $ (102,157) $ 36,404
Foreign currency translation adjustment (4,672) (936) (4,218) (3,763)
Unrealized (loss) gain on investments (10,720) 1,803 (4,016) (1,863)
Reclassification adjustment for realized
gains on investments -- (7,967) (5,842) (25,566)
---------------- ----------------- ----------------- ----------------
Total comprehensive (loss) income $(152,981) $ 7,350 $ (116,233) $ 5,212
================ ================= ================= ================
13
6. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted-average number of common shares and dilutive
employee stock options outstanding during the period. The weighted-average
dilutive stock options outstanding is computed using the treasury stock method.
For the three- and nine-month periods ended July 31, 2002, due to the net loss
incurred for such periods, the effect of employee stock options is
anti-dilutive.
The following is a reconciliation of the weighted-average common shares used
to calculate basic net earnings per share to the weighted-average common shares
used to calculate diluted net income per share:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- ---------------- --------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NUMERATOR
Net (loss) income $ (137,589) $ 14,450 $ (102,157) $ 36,404
=============== ================ =============== ================
DENOMINATOR:
Weighted-average common shares
outstanding 71,157 60,048 64,157 61,050
Effect of dilutive employee stock options - 4,839 - 4,312
--------------- ---------------- --------------- ----------------
Diluted common shares 71,157 64,887 64,157 65,362
=============== ================ =============== ================
Basic (loss) earnings per share $ (1.93) $ 0.24 $ (1.59) $ 0.60
=============== ================ =============== ================
Diluted (loss) earnings per share $ (1.93) $ 0.22 $ (1.59) $ 0.56
=============== ================ =============== ================
The effect of dilutive employee stock options excludes approximately
7,445,643 and 3,577,000 stock options for the three-month periods ended July 31,
2002 and 2001, respectively, and 5,339,772 and 3,513,000 for the nine-month
periods ended July 31, 2002 and 2001, respectively, which were anti-dilutive for
earnings per share calculations.
7. SEGMENT DISCLOSURE
Statement of Financial Accounting Standards No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION (SFAS 131), requires
disclosures of certain information regarding operating segments, products and
services, geographic areas of operation and major customers. The method for
determining what information to report under SFAS 131 is based upon the
"management approach," or the way that management organizes the operating
segments within a Company for which separate financial information is available
that is evaluated regularly by the Chief Operating Decision Maker (CODM) in
deciding how to allocate resources and in assessing performance. Synopsys' CODM
is the Chief Executive Officer and Chief Operating Officer.
The Company provides comprehensive design technology products and consulting
services in the EDA software industry. The CODM evaluates the performance of the
Company based on profit or loss from operations before income taxes not
including integration costs, in-process research and development and
amortization of intangible assets and deferred stock compensation. For the
purpose of making operating decisions, the CODM primarily considers financial
information presented on a consolidated basis accompanied by disaggregated
information about revenues by geographic region. There are no differences
between the accounting policies used to measure profit and loss for the Company
segment and those used on a consolidated basis. Revenue is defined as revenues
from external customers.
14
The disaggregated financial information reviewed by the CODM is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ---------------------------------
2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Revenue:
Product $ 60,096 $ 44,858 $ 151,944 $ 117,152
Service 73,924 81,430 208,782 259,900
Ratable license 102,075 49,822 236,552 119,736
---------------- ---------------- ---------------- ----------------
Total revenue $ 236,095 $ 176,110 $ 597,278 $ 496,788
================ ================ ================ ================
Gross margin before amortization of intangible
assets and deferred stock compensation $ 201,775 $ 143,390 $ 493,376 $ 401,056
Operating income (loss) before integration
costs, in-process research and development
and amortization of intangible assets and
deferred stock compensation $ 49,164 $ 5,914 $ 86,165 $ (851)
There were no integration, in-process research and development or
amortization of deferred stock compensation costs during the three- and
nine-month periods ended July 31, 2001.
A reconciliation of the Company's segment gross margin to the Company's
gross margin is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ---------------------------------
2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Gross margin before amortization of intangible
assets and deferred stock compensation $ 201,775 $ 143,390 $ 493,376 $ 401,056
Amortization of intangible assets and deferred
stock compensation (13,366) -- (13,366) --
---------------- ---------------- ---------------- ----------------
Gross margin $ 188,409 $ 143,390 $ 480,010 $ 401,056
================ ================ ================ ================
Reconciliation of the Company's segment profit and loss to the Company's
operating (loss) income before (benefit) provision for income taxes is as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
---------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ----------------- ---------------- -----------------
(IN THOUSANDS)
Operating income (loss) before integration
costs, in-process research and development
and amortization of intangible assets and
deferred stock compensation $ 49,164 $ 5,914 $ 86,165 $ (851)
Integration costs (117,266) -- (117,266) --
In-process research and development (82,500) -- (82,500) --
Amortization of intangible assets and deferred
stock compensation (22,186) (4,163) (30,586) (12,514)
---------------- ----------------- ---------------- -----------------
Operating (loss) income $ (172,788) $ 1,751 $ (144,187) $ (13,365)
================ ================= ================ =================
15
Revenue and long-lived assets related to operations in the United States and
other geographic areas are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------------- ----------------------------------
2002 2001 2002 2001
---------------- ---------------- ----------------- ----------------
(IN THOUSANDS)
Revenue:
United States $ 154,501 $ 110,770 $ 390,529 $ 306,650
Europe 34,992 33,460 98,584 91,214
Japan 25,758 18,405 59,783 53,060
Other 20,844 13,475 48,382 45,864
---------------- ---------------- ----------------- ----------------
Consolidated $ 236,095 $ 176,110 $ 597,278 $ 496,788
================ ================ ================= ================
JULY 31, OCTOBER 31,
2002 2001
---------------- ---------------
(IN THOUSANDS)
Long-lived assets:
United States $ 160,270 $ 176,330
Other 25,602 15,974
---------------- ---------------
Consolidated $ 185,872 $ 192,304
================ ===============
Geographic revenue data for multi-region, multi-product transactions reflect
internal allocations and is therefore subject to certain assumptions and to the
Company's methodology. Revenue is not reallocated among geographic regions to
reflect any re-mixing of licenses between different regions following the
initial product shipment. One customer accounted for approximately 15% and 10%
of the Company's consolidated revenue during the three- and nine-months ended
July 31, 2002, respectively. No one customer accounted for more than ten percent
of the Company's consolidated revenue during the three- and nine-months ended
July 31, 2001.
The Company segregates revenue into five categories for purposes of internal
management reporting: Design Implementation, Verification and Test, Design
Analysis, Intellectual Property (IP) and Professional Services. The following
table summarizes the revenue attributable to each of the various categories.
Revenue attributable to products acquired from Avant! that was recognized by
Avant! prior to June 6, 2002 is not reflected in the following tables. Revenue
attributable to such products from June 6, 2002 through July 31, 2002 is
included in the three- and nine- months ended July 31, 2002. As a result of the
Avant! merger, the Company has redefined its product groups. Prior period
amounts have been reclassified to conform to the new presentation.
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- ---------------- ---------------- ---------------
(IN THOUSANDS)
Revenue
Design Implementation $ 105,041 $ 68,726 $ 253,946 $ 192,817
Verification and Test 62,216 59,037 191,471 161,301
Design Analysis 40,616 11,300 61,745 30,216
IP 13,359 18,101 45,150 47,402
Professional Services 14,863 18,946 44,966 65,052
--------------- ---------------- ---------------- ---------------
Consolidated $ 236,095 $ 176,110 $ 597,278 $ 496,788
=============== ================ ================ ===============
8. DERIVATIVE FINANCIAL INSTRUMENTS
Available-for-sale equity investments accounted for under Statement of
Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES (SFAS 115), are subject to market price risk. From
time to time, the Company enters into and designates forward contracts to hedge
variable cash flows from anticipated sales of these investments. The Company
recorded a net realized gain on the sale of the available-for-sale investments
including the settlement of forward contracts of $10.3 million and $13.1 million
(net of premium amortization), respectively, during the three-month periods
ended July 31, 2002 and 2001 and $22.8 million and $41.9 million (net of premium
16
amortization), respectively, during the nine-month periods ended July 31, 2002
and 2001. As of July 31, 2002, the Company has recorded $7.6 million in
long-term investments due to locked-in unrealized gains on the
available-for-sale investments. As of July 31, 2002, the maximum length of time
over which the Company is hedging its exposure to the variability in future cash
flows associated with the forward sale contracts is 6 months.
9. TERMINATION OF AGREEMENT TO ACQUIRE IKOS SYSTEMS, INC.
On July 2, 2001, the Company entered into an Agreement and Plan of Merger
with IKOS Systems, Inc. (IKOS). The Agreement provided for the acquisition of
all outstanding shares of IKOS common stock by Synopsys.
On December 7, 2001, Mentor Graphics Corporation (Mentor) commenced a cash
tender offer to acquire all of the outstanding shares of IKOS common stock at
$11.00 per share, subject to certain conditions. On March 12, 2002, Synopsys and
IKOS executed a termination agreement by which the parties terminated the
Synopsys-IKOS merger agreement and pursuant to which IKOS paid Synopsys the $5.5
million termination fee required under the Synopsys-IKOS merger agreement. This
termination fee and $2.4 million of expenses incurred in conjunction with the
acquisition are included in other income, net on the unaudited condensed
consolidated statement of income for the nine-month period ended July 31, 2002.
Synopsys subsequently executed a revised termination agreement with Mentor and
IKOS in order to add Mentor as a party thereto.
10. WORKFORCE REDUCTION
In March 2002, the Company implemented a workforce reduction. The purpose
was to reduce expenses by decreasing the number of employees in all departments,
both domestically and internationally. As a result, the Company's workforce was
decreased by approximately 175 employees and a charge of approximately $3.9
million is included in operating expenses during the nine-month period ended
July 31, 2002. This charge consists of severance and other special termination
benefits.
11. DEFERRED STOCK COMPENSATION
In connection with the Avant! acquisition, the Company assumed unvested
stock options held by former Avant! employees. The Company has recorded deferred
stock compensation totaling $8.1 million based on the intrinsic value of the
assumed unvested stock options. The deferred stock compensation is amortized
over the options' remaining vesting period of one to three years. During the
three- and nine-months ended, July 31, 2002, the Company recorded amortization
of deferred stock compensation in each of the following expense classifications
on the statement of operations:
(IN THOUSANDS)
Cost of revenues $ 58
Research and development 309
Sales and marketing 105
General and administrative 38
--------
Total $510
========
12. CADENCE LITIGATION
Avant! and its subsidiaries are engaged in the Avant!/Cadence litigation, a
material civil litigation matter. The Avant!/Cadence litigation generally arises
out of the same set of facts that were the subject of a criminal action brought
against Avant! and several individuals by the District Attorney of Santa Clara
County, California (the "Santa Clara criminal action"). Avant!, Gerald C. Hsu,
Chairman of Avant! and five former Avant! employees pled no contest to certain
of the charges in the Santa Clara criminal action. As part of that plea, Avant!
paid approximately $35.3 million in fines and a hearing was held on the amount
of restitution owed to Cadence. During the hearing, Cadence claimed losses of
$683.3 million. Ultimately, the court in the Santa Clara criminal action
required Avant! to pay Cadence restitution in the amount of $195.4 million. That
amount has been fully paid.
Cadence seeks compensatory damages and treble or other exemplary damages
from Avant! in the Avant!/Cadence litigation under theories of copyright
infringement, misappropriation of trade secrets, inducing breach of contract and
false advertising. Synopsys believes Avant! has defenses to all of Cadence's
claims in the Avant!/Cadence litigation. Cadence has not fully quantified the
amount of damages it seeks in the Avant!/Cadence litigation. Should Cadence
17
ultimately succeed in the prosecution of its claims, however, Avant! could be
required to pay substantial monetary damages to Cadence. Some or all of these
damages may be offset by the $195.4 million restitution paid to Cadence in the
Santa Clara criminal action. Approximately $500 million in additional damages
would be covered by the insurance policy Synopsys has obtained with respect to
the Avant!/Cadence litigation.
Injunctions entered in 1997 and 1998 enjoined Avant! from marketing its
early place and route products, ArcCell and Aquarius, based on a judicial
determination that they incorporated portions of Cadence's Design Framework II
source code (DFII). The injunctions also prohibit Avant! from possessing, using,
selling or licensing any product or work copied or derived from DFII and
directly or indirectly marketing, selling leasing, licensing, copying or
transferring any of the ArcCell or Aquarius products. Avant! ceased marketing,
selling, leasing, licensing or supporting all of the ArcCell or Aquarius
products in 1996 and 1999, respectively. The DFII code is not incorporated in
any current Avant! product. Although Cadence has not made a claim in the
Avant!/Cadence litigation against any current Avant! product, including its
Apollo and Astro place and route products, and has not introduced any evidence
that any such product infringes Cadence's intellectual property rights, Cadence
has publicly implied that it intends to assert such claims. Synopsys believes it
would have defenses to any such claims. Nonetheless, should Cadence be
successful at proving that any past or then-current Avant! product incorporated
intellectual property misappropriated from Cadence, Synopsys could be
permanently enjoined from further use of such intellectual property, which might
require modification to existing products and/or suspension of the sale of such
products until such Cadence intellectual property was removed.
13. SUBSEQUENT EVENT - ACQUISITION OF INSILICON CORPORATION
On July 23, 2002, Synopsys entered into an Agreement and Plan of Merger
with inSilicon Corporation (inSilicon) under which Synopsys commenced a cash
tender offer to acquire all of the outstanding shares of inSilicon common stock
at $4.05 per share or approximately $64.9 million, subject to certain
conditions. Following the consummation of the tender offer, inSilicon will merge
with and into a wholly owned subsidiary of Synopsys. Synopsys will account for
the merger under the purchase method of accounting. The merger is subject to
certain conditions, including approval of the merger and the Agreement and Plan
of Merger by the inSilicon stockholders, compliance with regulatory requirements
and customary closing conditions.
14. SUBSEQUENT EVENT - ACQUISITION OF CO-DESIGN
On September 6, 2002, Synopsys acquired all of the outstanding shares of
capital stock of Co-Design Automation, Inc. (Co-Design) for consideration
consisting of cash and notes of $29.7 million and $4.8 million, respectively,
and assumed options with an aggregate value of approximately $1.3 million. The
Company will account for the merger under the purchase method of accounting.
Synopsys purchased Co-Design for a number of reasons, including (i) the
combination of Co-Design's technology with Synopsys' verification tools is
expected to speed the delivery of next-generation hardware description language
solutions; (ii) the acquisition will help promote the use of the Superlog
language, which Synopsys believes will be important in developing next
generation verification tools and increasing designer productivity; and (iii)
the acquisition gives Synopsys access to Co-Design's industry experts. As of the
date of filing this Form 10-Q, the valuation of Co-Design's assets and
liabilities, including identifiable intangible assets, as of the closing date
has not been completed.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. Such
forward-looking statements include the statements concerning the effect of
Technology Subscription Licenses on our revenue, expectations for revenue and
costs of revenue, expectations about gains from the sale of investments, effects
of foreign currency hedging, adequacy of our cash as well as statements
including the words "projects," "expects," "believes," "anticipates", "will" or
similar expressions. Actual results could differ materially from those
anticipated in such forward-looking statements as a result of certain factors,
including those set forth under "Factors That May Affect Future Results."
18
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to revenue recognition, bad debts, investments, intangible assets
and income taxes. Our estimates are based on historical experience and on
various other assumptions we believe are reasonable under the circumstances.
Actual results may differ from these estimates.
The accounting policies described below are the ones that most frequently
require us to make estimates and judgments, and are therefore critical to
understanding our results of operations.
REVENUE RECOGNITION AND COST OF REVENUE. Our revenue recognition policy is
detailed in Note 2 of the Notes to Unaudited Condensed Consolidated Financial
Statements. Management has made significant judgments related to revenue
recognition; specifically, evaluating whether our fee relating to an arrangement
is fixed or determinable and assessing whether collectibility is probable. These
judgments are discussed below.
THE VENDOR'S FEE IS FIXED OR DETERMINABLE. In order to recognize revenue, we
must make a judgment as to whether the arrangement fee is fixed or determinable.
Except in cases where we grant extended payment terms to a specific customer, we
have determined that our fees are fixed or determinable at the inception of our
arrangements based on the following:
o The fee our customers pay for our products is negotiated at the outset
of an arrangement and is generally based on the specific volume of
products to be delivered.
o Our license fees are not a function of variable-pricing mechanisms
such as the number of units distributed or copied by the customer or
the expected number of users of the product delivered.
Our customary payment terms are such that a minimum of 75% of the
arrangement fee is due within one year or less. These customary payment terms
are supported by historical practice and concessions have not been granted to
customers under this policy. Arrangements with payment terms extending beyond
the customary payment terms are considered not to be fixed or determinable.
Revenue from such arrangements is recognized at the lesser of the aggregate of
amounts due and payable or the amount of the arrangement fee that would have
been recognized if the fees had been fixed or determinable.
COLLECTIBILITY IS PROBABLE. In order to recognize revenue, we must make a
judgment of the collectibility of the arrangement fee. Our judgment of the
collectibility is applied on a customer-by-customer basis pursuant to our credit
review policy. We typically sell to customers for which there is a history of
successful collection. New customers are subjected to a credit review process,
which evaluates the customers' financial positions and ability to pay. New
customers are typically assigned a credit limit based on a formulated review of
their financial position. Such credit limits are only increased after a
successful collection history with the customer has been established. If it is
determined from the outset of an arrangement that collectibility is not probable
based upon our credit review process, revenue is recognized on a cash-collected
basis.
VALUATION OF STRATEGIC INVESTMENTS. As of July 31, 2002, the adjusted cost
of our strategic investments totaled $41.4 million. We review our investments in
non-public companies and estimate the amount of any impairment incurred during
the current period based on specific analysis of each investment, considering
the activities of and events occurring at each of the underlying portfolio
companies during the quarter. Our portfolio companies operate in industries that
are rapidly evolving and extremely competitive. For equity investments in
non-public companies where there is not a market in which their value is readily
determinable, we assess each investment for indicators of impairment at each
quarter end based primarily on achievement of business plan objectives and
current market conditions, among other factors, and information available to us
at the time of this quarterly assessment. The primary business plan objectives
we consider include, among others, those related to financial performance such
as achievement of planned financial results or completion of capital raising
activities, and those that are not primarily financial in nature such as the
launching of technology or the hiring of key employees. If it is determined that
an impairment has occurred with respect to an investment in a portfolio company,
in the absence of quantitative valuation metrics, management estimates the
impairment and/or the net realizable value of the portfolio investment based on
19
public- and private-company market comparable information and valuations
completed for companies similar to our portfolio companies. Future adverse
changes in market conditions, poor operating results of underlying investments
and other information obtained after our quarterly assessment could result in
losses or an inability to recover the current carrying value of the investments
thereby possibly requiring an impairment charge in the future. Based on these
measurements, an impairment loss of $4.0 million and $7.5 million was recorded
during the three- and nine-month periods ended July 31, 2002.
VALUATION OF INTANGIBLE ASSETS. Intangible assets, net of accumulated
amortization, totaled $351.2 million as of July 31, 2002. We periodically
evaluate our intangible assets for indications of impairment whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Intangible assets include goodwill, purchased technology and
capitalized software. Factors we consider important which could trigger an
impairment review include significant under-performance relative to expected
historical or projected future operating results, significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business or significant negative industry or economic trends. If this evaluation
indicates that the value of the intangible asset may be impaired, an evaluation
of the recoverability of the net carrying value of the asset over its remaining
useful life is made. If this evaluation indicates that the intangible asset is
not recoverable, based on the estimated undiscounted future cash flows of the
entity or technology acquired over the remaining amortization period, the net
carrying value of the related intangible asset will be reduced to fair value and
the remaining amortization period may be adjusted. Any such impairment charge
could be significant and could have a material adverse effect on our reported
financial statements if and when an impairment charge is recorded. If an
impairment charge is recognized, the amortization related to goodwill and other
intangible assets would decrease during the remainder of the fiscal year. No
impairment losses were recorded during the current quarter based on these
measurements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. As of July 31, 2002, the allowance for
doubtful accounts totaled $23.0 million. Management estimates the collectibility
of our accounts receivable on an account-by-account basis. We record an increase
in the allowance for doubtful accounts when the prospect of collecting a
specific account receivable becomes doubtful. In addition, we provide for a
general reserve on all accounts receivable, using a specified percentage of the
outstanding balance in each aged group. Management specifically analyzes
accounts receivable and historical bad debt experience, customer
creditworthiness, current economic trends, international exposures (such as
currency devaluation), and changes in our customer payment terms when evaluating
the adequacy of the allowance for doubtful accounts. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
INCOME TAXES. Our effective tax rate is directly affected by the relative
proportions of domestic and international revenue and income before taxes. We
are also subject to changing tax laws in the multiple jurisdictions in which we
operate. As of July 31, 2002, deferred tax assets and liabilities totaled $169.2
million and $23.3 million, respectively. We believe that it is more likely than
not that the results of future operations will generate sufficient taxable
income to utilize these net deferred tax assets. While we have considered future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the need for any valuation allowance, should we determine that we
would not be able to realize all or part of our net deferred tax asset in the
future, an adjustment to the deferred tax asset would be charged to income in
the period such determination was made.
RESULTS OF OPERATIONS
On June 6, 2002 (the "closing date"), the Company completed the merger with
Avant! Corporation (Avant!), a company which develops, markets, licenses and
supports electronic design automation software products that assist design
engineers in the physical layout, design, verification, simulation, timing and
analysis of advanced integrated circuits. Under the terms of the merger
agreement between the Company and Avant!, Avant! merged with and into a
wholly-owned subsidiary of Synopsys. The merger is accounted for under the
purchase method of accounting. The results of operations of Avant! are included
in the accompanying condensed consolidated financial statements for the period
from the closing date through July 31, 2002.
REVENUE. Revenue consists of fees for perpetual and ratable licenses of our
software products, sales of hardware system products, post-contract customer
support (PCS), customer training and consulting. We classify revenues as
product, service or ratable license. Product revenue consists primarily of
perpetual license product revenue. Service revenue consists of PCS under
perpetual licenses and fees for consulting services and training. Ratable
20
license revenue consists of all revenue from our technology subscription
licenses (TSLs) and from time-based licenses sold prior to the adoption of TSLs
in August 2000 that include extended payment terms or unspecified additional
products.
TSLs are time-limited rights to use our software. Since TSLs include
bundled product and services, both product and service revenue is generally
recognized ratably over the term of the license, or, if later, as payments
become due. The terms of TSLs, and the payments due thereon, may be structured
flexibly to meet the needs of the customer. In certain situations, customers
have limited rights to new technology through reconfiguration clauses under
their agreements.
We introduced TSLs in the fourth quarter of fiscal 2000. The replacement of
the prior form of time-based licenses by TSLs has impacted and will continue to
impact our reported revenue. When a customer buys a TSL, relatively little
revenue is recognized during the quarter the product is initially delivered. The
remaining amount will either be recorded as deferred revenue on our balance
sheet or considered backlog by the Company and not recorded on the balance
sheet. The amount recorded as deferred revenue is equal to the portion of the
license fee that has been invoiced or paid but not recognized. The amount
considered backlog moves out of backlog and is recorded as deferred revenue as
invoiced or as additional payments are made. Deferred revenue is reduced as
revenue is recognized. Under the prior form of time-based licenses, a high
proportion of all license revenue was recognized in the quarter that the product
was delivered, with relatively little recorded as deferred revenue or as
backlog. Therefore, an order for a TSL will result in significantly lower
current-period revenue than an equal-sized order under the prior form of
time-based licenses.
Since our introduction of TSLs, the average TSL duration has been
approximately 3.25 years. This means that, absent the Avant! merger, the
transition of our license base to TSLs would continue to impact our reported
revenue until at least the first quarter of fiscal year 2004. This transition
period will be extended as a result of our merger with Avant!. Avant!'s
historical license order mix had a higher proportion of perpetual licenses and a
lower proportion of ratable licenses than the Synopsys license order mix from
August 2000 to the present (i.e., since our adoption of TSLs), which has been
22% perpetual licenses and 78% ratable licenses. We expect that the future
license order mix of the combined company will approach, over time, the Synopsys
license mix, though it is likely to fluctuate from quarter to quarter.
We set revenue targets for any given quarter based, in part, upon an
assumption that we will achieve a certain license mix of perpetual licenses and
TSLs. The actual mix of licenses sold affects the revenue we recognize in the
period. If we are unable to achieve our target license mix, we may not meet our
revenue targets. Our target license mix for total new software license orders
for the fourth quarter of fiscal year 2002 is 20% to 25% perpetual licenses and
75% to 80% ratable licenses. For fiscal year 2003, our preliminary target
license mix for total new software license orders is 22% to 27% perpetual
licenses and 73% to 78% ratable licenses. These ranges are preliminary and are
subject to revision based on developments in our business. In addition, the
precise mix of orders is subject to substantial fluctuation in any given quarter
or multiple quarter period. In the third quarter of fiscal 2002, the license mix
was approximately 32% perpetual licenses and 68% TSLs, in comparison to 29%
perpetual licenses and 71% TSLs in the third quarter of fiscal 2001.
As expected, total revenue for the third quarter of fiscal 2002 increased
34% to $236.1 million compared to $176.1 million for the third quarter of fiscal
2001. Revenue for the nine months ended July 31, 2002 increased 20% to $597.3
million compared to $496.8 million for the nine months ended July 31, 2001. The
increase in total revenue for the three- and nine months ended July 31, 2002
compared to the same periods in 2001 is due primarily to the Avant! acquisition,
and to the additional quarters that the TSL license model has been used and the
related increase in revenue due to the timing of revenue recognition under this
model.
Product revenue increased 34% to $60.1 million for the third quarter of
fiscal 2002, compared to $44.9 million for the third quarter of fiscal 2001 and
30% to $151.9 million for the nine months ended July 31, 2002 compared to $117.2
million for the same period in fiscal 2001. The increase in product revenue is
directly related to the increase in orders for perpetual licenses during the
periods, since, in most cases, product revenue is recognized in the same quarter
that an order for a perpetual license is received and to the increased volume as
a result of the Avant! merger. During the second quarter of 2002, we began
offering variable maintenance arrangements to certain customers that entered
into perpetual license technology arrangements in excess of $2.0 million. Under
these arrangements, the annual fee for PCS is calculated as a percentage of the
net license fee rather than a fixed percentage of the list price.
Service revenue decreased 9% to $73.9 million for the third quarter of
fiscal 2002, compared to $81.4 million for the third quarters of fiscal 2001,
and decreased 20% to $208.8 million for the nine months ended July 31, 2002
21
compared to $259.9 million for the same period in fiscal 2001. The decreases in
both periods are due in part to economic factors and in part to the impact of
our adoption of TSLs on our overall license mix. Economic conditions have led
our customers to reduce their costs by curtailing their use of outside
consultants and, in some cases, discontinuing maintenance on their perpetual
license. As a result, we received a lower volume of new consulting orders than
expected, and certain projects in the consulting backlog were deferred or
cancelled. Customer expenditures on training have also been reduced, which has
reduced our revenue from training. These conditions are expected to continue at
least until the semiconductor industry recovers. The shift to TSLs has impacted
service revenue in two ways. First, new licenses structured as TSLs include
bundled PCS, which means that revenue attributable to PCS is recognized as
ratable revenue. If such licenses were perpetual licenses or time-based licenses
similar to the type that we used to offer, the PCS revenue relating to such
licenses would be recognized as service revenue. Second, customers with existing
perpetual licenses are entering into new TSLs rather than renewing the PCS on
the existing perpetual licenses. In each case, revenue attributable to PCS that
otherwise would have been reflected in service revenue is now reflected in
ratable license revenue.
REVENUE EXPECTATIONS. For the fourth quarter of fiscal year 2002, we expect
revenue to consist of 25% to 30% product revenue, 45% to 50% TSLs and 25% to 30%
services revenue. For the full fiscal year 2003, we expect revenue to consist of
15% to 20% product revenue, 50% to 55% TSLs and 25% to 30%services revenue.
INTERNATIONAL REVENUE. The following table summarizes the performance of
the various geographic regions as a percent of total Company revenue:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------- ------------- ------------
North America 65% 63% 65% 62%
Europe 15% 19% 17% 18%
Japan 11% 10% 10% 11%
Asia Pacific and Other 9% 8% 8% 9%
------------ ------------- ------------- ------------
Total 100% 100% 100% 100%
============ ============= ============= ============
International revenue as a percentage of total revenue for the quarter ended
July 31, 2002 decreased to 35% from 37% for the quarter ended July 31, 2001 and
to 35% from 38% for the nine-month periods ended July 31, 2002 and 2001,
respectively. In any given period, the geographic mix of revenue is influenced
by the particular contracts signed during the quarter and in prior quarters.
International sales are vulnerable to regional or worldwide economic or
political conditions. In particular, a number of our largest European customers
are in the telecommunications equipment business, which has weakened
considerably, resulting in a quarterly decline in revenues from Europe as a
percentage of total Company revenue during fiscal 2002. The majority of our
international sales are denominated in the U.S. dollar. There were no foreign
exchange gains or losses that were material to our financial results during the
three- and nine-month periods ended July 31, 2002 and 2001.
REVENUE - PRODUCT GROUPS. For management reporting purposes, our products
have been organized into four distinct product groups -- Design Implementation,
Verification and Test, Design Analysis, Intellectual Property (IP) -- and a
services group -- Professional Services. The following table summarizes the
revenue attributable to the various groups as a percentage of total Company
revenue for the last eight quarters. Revenue attributable to products acquired
from Avant! that was recognized by Avant! prior to June 4, 2002 is not reflected
in the following tables. Revenue attributable to such products from June 6, 2002
through July 31, 2002 is included in the third quarter fiscal 2002 revenue. As a
result of the Avant! merger, we have redefined our product groups. Prior period
amounts have been reclassified to conform to the new presentation.
Q3-2002 Q2-2002 Q1-2002 Q4-2001 Q3-2001 Q2-2001 Q1-2001 Q4-2000
------------- ------------ ------------ ------------ ------------ ------------ ------------ -----------
Revenue
Design Implementation 45% 42% 40% 42% 39% 39% 38% 40%
Verification and Test 26 34 37 33 34 32 31 30
Design Analysis 17 6 6 6 6 5 7 5
IP 6 9 9 10 10 9 10 11
Professional Services 6 9 8 9 11 15 14 14
------------- ------------ ------------ ------------ ------------ ------------ ------------ -----------
Total Company 100% 100% 100% 100% 100% 100% 100% 100%
============= ============ ============ ============ ============ ============ ============ ===========
22
DESIGN IMPLEMENTATION. Design Implementation includes products used for the
design of a chip from a high level functional description to a complete
description of the transistors and wires that implement such functions that can
be delivered to a semiconductor company for manufacturing (a process often
referred to as "RTL to GDSII"), including synthesis, physical synthesis, floor
planning and place-and-route products and technologies. The principal products
in this category are Design Compiler, FPGA Compiler, Physical Compiler, Chip
Architect, Floorplan Compiler, Jupiter, Apollo, Astro and related products.
Design Implementation, as a percent of revenue, fluctuated between 38% and 42%
in the period from the fourth quarter of fiscal 2000 through the second quarter
of fiscal 2002, and exhibited a generally increasing trend from the first
quarter of fiscal 2001 through the second quarter of fiscal 2002. This trend
reflects the Company's growing portfolio of Design Implementation products
during the period, most notably the introduction of Physical Compiler, and the
growing importance of design implementation products in solving customers design
problems. The 3% increase from the second quarter of fiscal 2002 to the third
quarter of fiscal 2002 is due principally to the addition of Avant! products to
this category, since the largest portion of Avant!'s revenue was derived from
products (including its principal place and route products) that were added to
the Design Implementation category.
VERIFICATION AND TEST. Verification and Test includes products used for
verification and analysis performed at the system level, register transfer level
(RTL) and gate level of design, including simulation, system level design and
verification, timing analysis, formal verification, test and related products.
The principal products in this category are VCS, Polaris, Vera, PathMill,
CoCentric System Studio, PrimeTime, Formality, Design Verifyer, DFT Compiler and
TetraMax. As a percent of revenue, revenue from this product family fluctuated
between 30% and 34% in the period from the fourth quarter of fiscal 2000 through
the second quarter of fiscal 2002, principally attributable to the mix of
perpetual versus time-based license orders received for Verification and Test
products during any given quarter. Revenue as a percent of total revenue
increased through the second quarter of fiscal 2002 as a result of the quarterly
amortization of deferred revenue related to the ratable license model. From the
second quarter of fiscal 2002 to the third quarter of fiscal 2002, Verification
and Test revenues as a percent of total Company revenue decreased, principally
because the Verification and Test product group does not include many products
acquired from Avant!. In terms of absolute dollars, revenues from this product
group remained relatively flat.
DESIGN ANALYSIS. Design Analysis includes products used for verification and
analysis performed at the transistor level and physical level of design,
including analog and mixed signal circuit simulation, design rule checking,
power analysis, customer design, semiconductor process modeling and reliability
analysis. The principal products in this category are NanoSim, StarSim, HSPICE,
StarRC, Arcadia, TCAD, Hercules, Venus, OPC, PrimePower and Cosmos. Revenue from
this product group as a percentage of total revenues has ranged between 5% and
7% since the introduction of TSLs as a result of the mix of perpetual versus
time-based license orders received during a particular quarter. During the third
quarter of fiscal 2002, revenue from this product group as a percentage of total
revenues increased to 17%, due primarily to the Avant! acquisition, as the
second largest portion of Avant!'s revenue was derived from products that were
added to the Design Analysis category.
INTELLECTUAL PROPERTY. Our IP products include the DesignWare library of
design components and verification models. Revenue as a percent of total revenue
decreased from the fourth quarter of fiscal 2000 to the third quarter of fiscal
2002 from 11% to 6%, respectively, due in part to the fact that the term of many
of these licenses has increased from one to three years and the revenue is
recognized over a longer period of time. From the second quarter of fiscal 2002
to the third quarter of fiscal 2002, IP revenues as a percent of total Company
revenue decreased principally because the IP product group does not include many
products acquired from Avant!
PROFESSIONAL SERVICES. The Professional Services group includes consulting
and training activities. This group provides consulting services, including
design methodology assistance, specialized telecommunications systems design
services and turnkey design. Revenue from professional services as a percentage
of total revenues has declined from 14% in the fourth quarter of fiscal 2000 to
6% in the third quarter of fiscal 2002, reflecting, as described above under
"Revenue", the impact of the economic environment.
COST OF REVENUE. Cost of revenue consists of the cost of product revenue,
cost of service revenue and cost of ratable license revenue and amortization of
intangible assets and deferred stock compensation. Cost of product revenue
includes personnel and related costs, production costs, product packaging,
documentation, amortization of capitalized software development costs and
purchased technology, and costs of the components of our hardware system
products. The cost of internally developed capitalized software is amortized
based on the greater of the ratio of current product revenue to the total of
current and anticipated product revenue or the straight-line method over the
23
software's estimated economic life of approximately two years. Cost of service
revenue includes consulting services, personnel and related costs associated
with providing training and PCS on perpetual licenses. Cost of ratable license
revenue includes the costs of product and services related to our TSLs, since
TSLs include bundled product and services. Cost of product revenue, cost of
service revenue and cost of ratable license revenue are heavily dependent on an
on the mix of software orders received during the period.
Cost of product revenue decreased to 7% of total product revenue for the
three months ended July 31, 2002 compared to 14% for the same period during
2001. Cost of product revenue was 8% and 15% for the nine months ended July 31,
2002 and 2001, respectively. This decrease in cost of product revenue as a
percentage of total product revenue for the three- and nine-month periods ended
July 31, 2002 as compared to 2001 is due in part to the wind-down of our
internet business unit during the third quarter of fiscal 2001, and in part to
certain direct costs related to commitments that were incurred during the third
quarter of fiscal 2001 resulting from the sale of our silicon libraries
business.
Cost of service revenue as a percentage of total service revenue was 27% and
24% for the third quarters of fiscal 2002 and 2001, respectively, and increased
to 28% from 22% for the nine months ended July 31, 2002 and 2001, respectively.
The increase in cost of service revenue as a percentage of total service revenue
is due primarily to the decline in total service revenue and to decreased
utilization of our professional services personnel, both as a result of the
economic environment.
Cost of ratable license revenue was 10% in the third quarter of fiscal 2002
compared to 15% for the third quarter of 2001 and was 15% and 16% for the nine
months ended July 31, 2002 and 2001, respectively. The cost of ratable license
revenue as a percent of ratable revenue is impacted by the mix of orders between
product, service and ratable revenue during the particular quarter as well as an
increase in quarterly amortization of deferred revenue and backlog, which is an
inherent result of the use of the ratable license model.
Amortization of intangible assets and deferred stock compensation includes
the amortization of the contract rights intangible asset associated with certain
executory contracts, as discussed under "ACQUISITION OF AVANT! CORPORATION"
below, and the amortization of core/developed technology acquired in the Avant!
merger. Total amortization of these intangible assets for the three- and
nine-month periods ended July 31, 2002 was $2.7 million and $10.2 million,
respectively. In connection with the Avant! acquisition, the Company also
assumed unvested stock options held by Avant! employees. The Company has
recorded deferred stock compensation totaling $8.1 million based on the
intrinsic value of these assumed unvested stock options. The deferred stock
compensation is amortized over the options' remaining vesting period of one to
three years. During the three- and nine-months ended July 31, 2002, we recorded
amortization of deferred stock compensation in each of the following expense
classifications on the statement of operations:
(IN THOUSANDS)
Cost of revenues $ 58
Research and development 309
Sales and marketing 105
General and administrative 38
--------
Total $510
COST REDUCTION PROGRAM. During the first quarter of fiscal 2002, as part of
an overall cost reduction program, the Company implemented a workforce reduction
affecting all departments, both domestically and internationally. As a result,
the Company's workforce was reduced by approximately 175 employees and a charge
of approximately $3.9 million was included in operating expenses during the
second quarter of fiscal 2002. This charge consists of severance and other
special termination benefits. These costs are reflected in the statement of
operations as follows:
(IN THOUSANDS)
Cost of revenues $ 678
Research and development 1,081
Sales and marketing 1,078
General and administrative 1,033
-----------
Total 3,870
===========
RESEARCH AND DEVELOPMENT. Research and development expenses increased to
$61.6 million during the third quarter of fiscal 2002 compared to $49.4 million
for the third quarter of fiscal 2001. Research and development expenses
represented 26% and 28% of total revenue in the third fiscal quarter of 2002 and
2001, respectively. The increase in research and development expenses resulted
principally from the increase in headcount as a result of the Avant!
24
acquisition. The increased expenditures consist principally of increases of $8.8
million in compensation expense, $2.0 million in depreciation expense and of
$5.3 million in research and development-related human resources, technology and
facilities costs. These increases are offset by decreases of $1.9 million in
consulting and contractor costs and $1.9 million in other costs including
travel, communications and supplies as a result of the Company's cost reduction
programs.
Research and development expenses were $156.9 million for the nine-month
period ended July 31, 2002 and $143.2 million for the nine-month period ended
July 31, 2001. As a percentage of total revenue, research and development
expenses represented 26% and 29% for the nine-month periods ended July 31, 2002
and 2001, respectively. The increase in terms of dollars is due to the increase
in compensation and compensation-related costs of $14.0 million related to
higher levels of research and development staffing as a result of the Avant!
acquisition and annual merit and cost of living increases, which were
implemented in the second quarter of 2001. Depreciation expense also increased
$3.2 million and human resources, technology and facilities costs for research
and development increased $5.1 million as a result of the increase in research
and development staffing. These increases are offset by decreases in expenses
related to consultants and other expenses, including facilities, travel,
communications, supplies and recruiting, which decreased $4.5 million and $3.5
million, respectively, as a result of our cost reduction programs.
SALES AND MARKETING. Sales and marketing expenses remained relatively flat
at $69.1 million the third quarter of fiscal 2002 compared to $69.0 million in
the same quarter last year. Sales and marketing expenses represented 29% and 39%
of total revenue in the third fiscal quarter of 2002 and 2001, respectively. In
the three-month period in fiscal 2002 compared to fiscal 2001, in terms of
dollars, compensation and compensation-related costs increased $3.6 million due
to the Avant! acquisition. These increases were offset by decreases in
advertising expenses of $1.0 million due to the fact that the Company launched a
brand recognition program during the third quarter of fiscal 2001, resulting in
additional expenses in 2001. The corporate costs allocated to sales and
marketing also decreased $2.5 million as a result of a decrease in human
resources, technology and facilities costs as a result of decreased sales and
marketing headcount as a percentage of total headcount.
Sales and marketing expenses were $192.1 million and $207.7 million (32% and
42% of total revenue) for the nine-month periods ended July 31, 2002 and 2001,
respectively. The decrease in the nine-month period in fiscal 2002 in comparison
to the fiscal 2001 period, in terms of dollars, resulted from a decrease in
compensation and compensation-related costs of $4.1 million due to a decline in
sales commissions and a decrease in the cost of benefits related to a change in
our health and welfare benefit programs. These decreases were offset by an
increase in compensation related to additional employees added during the third
quarter as a result of the Avant! acquisition. Human resources, technology and
facilities costs also decreased $5.6 million as a result of a decrease in sales
and marketing headcount as a percentage of total headcount. Employee functions,
consulting expenses, and other expenses including facilities, travel and
information technology also decreased $1.1 million, $2.3 million and $2.1
million, respectively, as a result of the Company's cost reduction efforts.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
14% to $21.9 million in the third quarter of fiscal 2002, compared to $19.1
million in the same quarter last year. General and administrative expenses
represented 9% and 11% of total revenue for the three-month periods ended July
31, 2002 and 2001, respectively. This increase is due in part to an increase in
litigation expenses relating to certain legal actions. Compensation and
compensation-related costs increased $2.2 million, communications costs of $1.5
million and facilities costs of $3.6 million due to the acquisition of Avant!.
These increases were offset by decreases in consulting costs of $2.6 million as
a result of the Company's cost reduction efforts and human resources, technology
and facilities costs decreased $6.2 million as a result of a decrease in the
percentage of general and administrative headcount.
General and administrative expenses increased 14% to $58.2 million from
$50.9 million for the nine months ended July 31, 2002 and 2001, respectively.
General and administrative expenses represented 10% of total revenue in each of
the nine-month periods ended July 31, 2002 and 2001. This increase is due in
part to an increase in litigation expenses relating to certain legal actions
initiated by Synopsys. In addition, compensation and compensation-related costs
increased $2.3 million, communications costs increased $1.9 million, and
facilities costs increased $9.8 million as a result of the Avant! acquisition.
These increases were offset by decreased consulting costs of $3.0 million as a
result of the Company's cost reduction efforts and decreased human resources,
technology and facilities costs of $13.0 million as a result of a decrease in
general and administrative headcount.
AMORTIZATION OF INTANGIBLE ASSETS. Goodwill represents the excess of the
aggregate purchase price over the fair value of the tangible and identifiable
intangible assets we have acquired. Intangible assets and goodwill are amortized
over their estimated useful lives of three to six years. We assess the
25
recoverability of goodwill by estimating whether the unamortized cost will be
recovered through estimated future undiscounted cash flows. Amortization of
intangible assets charged to operations in the third quarter of fiscal 2002 was
$8.8 million compared to $4.2 million for the same period last year.
Amortization of intangible assets charged to operations was $17.2 million and
$12.5 million for the nine months ended July 31, 2002 and 2001, respectively.
The increased amortization in the fiscal 2002 periods is due to the amortization
of intangible assets acquired in the Avant! merger. The Financial Accounting
Standards Board recently issued new guidance with respect to the amortization
and evaluation of goodwill. This new guidance is discussed below under "Effect
of New Accounting Standards".
OTHER INCOME, NET. Other income, net was $11.4 million in the third quarter
of fiscal 2002 compared to $19.5 million in the same quarter in the prior year.
This decrease is due in part to the lower level of gains recognized on the sale
of securities, which were $10.3 million during the third quarter of fiscal 2002
compared to $13.1 million for the same period during 2001. Interest income for
the third quarter of 2002 was $2.4 million compared to $2.7 million for the
third quarter of 2001. Although cash balances were higher as of July 31, 2002
than a year ago, significantly lower interest rates and the Company's shift of
its investments into shorter maturity instruments in anticipation of the Avant!
merger resulted in a decrease in interest income. Rental income in the third
quarter of fiscal 2002 and 2001 was $2.6 million and $2.5 million, respectively.
The third quarter of fiscal 2002 includes investment impairment charges of
approximately $4.0 million to write down the carrying value of certain assets
held in our venture fund to the best estimate of net realizable value.
Other income, net was $33.7 million and $66.9 million for the nine months
ended July 31, 2002 and 2001, respectively. The nine-month decrease is due in
part to the gain of $10.6 million on the sale of our silicon libraries business
to Artisan during 2001 and in part to realized gains on investments, which were
$22.7 million for fiscal 2002 as compared to $43.1 million for fiscal 2001.
These gains were partially offset by the write-down of certain assets in our
venture portfolio in the amount of $7.5 million and $4.3 million for the nine
months of fiscal 2002 and 2001, respectively. Interest income in the nine months
ended July 31, 2002 was $6.9 million, as compared to $10.5 million in the same
quarter last year. Although cash balances were higher as of July 31, 2002 than a
year ago, a significantly lower interest rate environment and a shortened
average investment maturity in anticipation of the Avant! acquisition resulted
in a decrease in interest income. The nine months ended July 31, 2002 also
include a gain of $3.1 million related to the termination fee for the IKOS
agreement, net of costs incurred. Further, rental income was $7.5 million and
$6.2 for the nine-month periods ended July 31, 2002 and 2001, respectively. The
remaining changes to other income, net relate to the amortization of premium
forwards and foreign exchange gains and losses recognized during the nine-month
period.
During the nine months ended July 31, 2002 and 2001, we determined that
certain of the assets held in our venture fund valued at $9.5 million and $6.6
million, respectively, were impaired and that the impairment was other than
temporary. Accordingly, we recorded charges of approximately $7.5 million and
$4.3 million for the nine months ended July 31, 2002 and 2001, respectively, to
write down the carrying value of the investments to the best estimate of net
realizable value. Impairment charges relate to certain investments in non-public
companies and represent management's estimate of the impairment incurred during
the period as a result of specific analysis of each investment, considering the
activities of and events occurring at each of the underlying portfolio companies
during the quarter. Our portfolio companies operate in industries that are
rapidly evolving and extremely competitive. For equity investments in non-public
companies where there is not a market in which their value is readily
determinable, we assess each investment for indicators of impairment at each
quarter-end based primarily on achievement of business plan objectives and
current market conditions, among other factors, and information available to us
at the time of this quarterly assessment. The primary business plan objectives
we consider include, among others, those related to financial performance such
as achievement of planned financial results or completion of capital raising
activities, and those that are not primarily financial in nature such as the
launching of technology or the hiring of key employees. If it is determined that
an impairment has occurred with respect to an investment in a portfolio company,
in the absence of quantitative valuation metrics, management estimates the
impairment and/or the net realizable value of the portfolio investment based on
public- and private-company market comparable information and valuations
completed for companies similar to our portfolio companies.
INTEREST RATE RISK. Our exposure to market risk for a change in interest
rates relates to our investment portfolio. We place our investments in a mix of
short-term tax exempt and taxable instruments that meet high credit quality
standards, as specified in our investment policy. This policy also limits the
amount of credit exposure to any one issue, issuer and type of instrument. We do
not anticipate any material losses with respect to our short-term investment
portfolio.
26
The following table presents the carrying value and related weighted-average
total return for our investment portfolio. The carrying value approximates fair
value at July 31, 2002. In accordance with our investment policy, the
weighted-average duration of our total invested funds does not exceed one year.
Principal (Notional) Amounts in U.S. Dollars:
WEIGHTED-AVERAGE
CARRYING AFTER TAX
(IN THOUSANDS, EXCEPT INTEREST RATES) AMOUNT TOTAL RETURN
----------------- ---------------------
Short-term investments - fixed rate 96,647 4.09%
Short-term investments (RESTRICTED) - fixed rate 1,900 1.56%
Cash-Equivalent investments (RESTRICTED)- variable rate 3,597 1.10%
Money market funds - variable rate 236,678 1.28%
-----------------
Total interest bearing instruments $ 338,822 2.08%
=================
FOREIGN CURRENCY RISK. At the present time, we do not generally hedge
anticipated foreign currency cash flows but hedge only those currency exposures
associated with certain assets and liabilities denominated in nonfunctional
currencies. Hedging activities undertaken are intended to offset the impact of
currency fluctuations on these balances. The success of this activity depends
upon the accuracy of our estimates of balances denominated in various
currencies, primarily the Euro, Japanese yen, Taiwan dollar, British pound
sterling, Canadian dollar, Singapore dollar, Korean Won and Israeli Shekel. We
had contracts for the sale and purchase of foreign currencies with a notional
value expressed in U.S. dollars of $255.1 million as of July 31, 2002. Looking
forward, we do not anticipate any material adverse effect on our consolidated
financial position, results of operations, or cash flows resulting from the use
of these instruments. There can be no assurance that these hedging transactions
will be effective in the future.
The following table provides information about our foreign exchange forward
contracts at July 31, 2002. Due to the short-term nature of these contracts, the
contract rate approximates the weighted-average contractual foreign currency
exchange rate at July 31, 2002. These forward contracts mature in approximately
thirty days.
Short-Term Forward Contracts to Sell and Buy Foreign Currencies in U.S.
Dollars:
USD AMOUNT CONTRACT RATE
---------------- ---------------
(IN THOUSANDS, EXCEPT FOR CONTRACT RATES)
Forward Net Contract Values:
Euro $ 202,024 1.0148
Japanese yen 24,645 118.3700
Taiwan dollar 15,285 33.7670
Korean Won 3,310 1,196.2500
Israeli Shekel 1,319 4.7400
Canadian dollar 5,784 1.5744
Singapore dollar 2,770 1.7633
----------------
$ 255,137
================
The unrealized gains/losses on the outstanding forward contracts at July 31,
2002 were immaterial to our consolidated financial statements. The realized
gain/losses on these contracts as they matured were not material to our
consolidated financial position, results of operations or cash flows for the
periods presented.
We apply Statement of Financial Accounting Standards No. 133 (SFAS 133),
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended, in
accounting for our derivative financial instruments. SFAS 133 establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized as either
assets or liabilities at fair value. Derivatives that are not designated as
hedging instruments are adjusted to fair value through earnings. If the
derivative is designated as a hedging instrument, depending on the nature of the
exposure being hedged, changes in fair value will either be offset against the
change in fair value of the hedged asset, liability, or firm commitment through
earnings, or recognized in other comprehensive income until the hedged
anticipated transaction affects earnings. The ineffective portion of the hedge
is recognized in earnings immediately. We do not believe that ongoing
application of SFAS 133 will significantly alter our hedging strategies.
However, its application may increase the volatility of other income and expense
27
and other comprehensive income. Apart from our foreign currency hedging and
forward sales of certain equity investments, we do not use derivative financial
instruments. In particular, we do not use derivative financial instruments for
speculative or trading purposes.
TERMINATION OF AGREEMENT TO ACQUIRE IKOS SYSTEMS, INC. On July 2, 2001, we
entered into an Agreement and Plan of Merger and Reorganization (the "Merger
Agreement") with IKOS Systems, Inc. (IKOS). The Merger Agreement provided for
the acquisition of all outstanding shares of IKOS common stock by Synopsys.
On December 7, 2001, Mentor Graphics Corporation (Mentor) commenced a cash
tender offer to acquire all of the outstanding shares of IKOS common stock at
$11.00 per share, subject to certain conditions. On March 12, 2002, Synopsys and
IKOS executed a termination agreement by which the parties terminated the
Synopsys-IKOS merger agreement and pursuant to which IKOS paid Synopsys the $5.5
million termination fee required by the Synopsys-IKOS merger agreement. This
termination fee and $2.4 million of expenses incurred in conjunction with the
acquisition are included in other income, net on the unaudited condensed
consolidated statement of income for the nine month period ended July 31, 2002.
Synopsys subsequently executed a revised termination agreement with Mentor and
IKOS in order to add Mentor as a party thereto.
ACQUISITION OF AVANT! CORPORATION. On June 6, 2002 (the "closing date"), the
Company completed its merger with Avant!.
REASONS FOR THE ACQUISITION. The Company's Board of Directors unanimously
approved the Company's merger with Avant! at its December 1, 2001 meeting. In
approving the merger agreement, the Board of Directors consulted with legal and
financial advisors as well as with management and considered a number of
factors. These factors include the fact that the merger is expected to enable
Synopsys to offer its customers a complete end-to-end solution for
system-on-chip design that includes Synopsys' logic synthesis and design
verification tools with Avant!'s advanced place and route, physical verification
and design integrity products, thus increasing customers' design efficiencies.
By increasing customer design efficiencies, Synopsys expects to be able to
better compete for customers designing the next generation of semiconductors.
Further, by gaining access to Avant!'s physical design and verification
products, as well as its broad customer base and relationships, Synopsys will
gain new opportunities to market its existing products. The foregoing discussion
of the information and factors considered by the Company's Board of Directors is
not intended to be exhaustive but includes the material factors considered by
the Company's Board of Directors.
PURCHASE PRICE. Holders of Avant! common stock received 0.371 of a share of
Synopsys common stock (including the associated preferred stock rights) in
exchange for each share of Avant! common stock owned as of the closing date,
aggregating 14.5 million shares of Synopsys common stock. The fair value of the
Synopsys shares issued was based on a per share value of $54.74, which is equal
to Synopsys' average last sale price per share as reported on the Nasdaq
National Market for the trading-day period two days before and after December 3,
2001, the date of the merger agreement.
The total purchase consideration consists of the following:
(IN THOUSANDS)
Fair value of Synopsys common stock issued $ 795,388
Estimated acquisition related costs 37,342
Estimated facilities closure costs 62,638
Estimated employee severance costs 50,367
Estimated fair value of options to purchase
Synopsys common stock to be issued, less
$8.1 million representing the portion of the
intrinsic value of Avant!'s unvested options
applicable to the remaining vesting period 63,033
-----------------
$ 1,008,768
=================
The estimated acquisition-related costs of $37.3 million consist primarily
of banking, legal and accounting fees, printing costs, and other directly
related charges including contract termination costs of $6.7 million. The
Company is currently reviewing all outstanding Avant! contracts to determine the
cost, if any, to exit existing contracts which may result in additional accruals
for contract termination costs in accordance with Emerging Issues Task Force
(EITF) Issue No. 95-3. Any such accruals would increase the purchase
consideration and the allocation of the purchase consideration to goodwill.
Estimated facilities closure costs includes $54.2 million related to
Avant!'s corporate headquarters. The lessor has brought a claim against the
28
Company for the future amounts payable under the lease agreements. The amount
accrued at the closing date is equal to the future amounts payable under the
related lease agreements, without taking into consideration in the accrual any
defenses we may have to the claim. Resolution of this contingency at an amount
different from that accrued will result in an increase or decrease in the
purchase consideration and the amount allocated to goodwill. The remaining
estimated facilities closure costs totaling $8.4 million represents the present
value of the future obligations under certain of Avant!'s lease agreements which
the Company has or intends to terminate under an approved facilities exit plan
plus additional costs expected to be incurred directly related to vacating such
facilities.
Estimated employee severance costs include (i) $39.6 million in cash paid to
Avant!'s Chairman of the Board, consisting of severance plus a cash payment
equal to the intrinsic value of his in-the-money stock options at the closing
date, (ii) $4.5 million in cash severance payments paid to redundant employees
(primarily sales and corporate infrastructure personnel) terminated on or
subsequent to the consummation of the merger under an approved plan of
termination and (iii) $6.3 million in termination payments to certain executives
in accordance with their respective pre-merger employment agreements. The total
number of Avant! employees expected to be terminated as a result of the merger
is approximately 250.
As of July 31, 2002, $73.3 million of costs described in the three preceding
paragraphs have been paid and $77.1 million of these costs have not yet been
paid. The following table presents the components of acquisition-related costs
recorded, along with amounts paid through the third quarter of 2002.
Payments
Total Cost through Balance at
(IN THOUSANDS) July 31, 2002 July 31, 2002
------------ ---------------- ----------------
Estimated acquisition related costs $ 37,342 $23,967 $13,375
Estimated facilities closure costs 62,638 262 62,376
Estimated employee severance costs 50,367 49,031 1,336
------------ ---------------- ----------------
Total $150,347 $73,260 $77,087
============ ================ ================
The total purchase consideration has been allocated on a preliminary basis
to the assets and liabilities acquired, including identifiable intangible
assets, based on their respective fair value at the acquisition date and
resulted in excess purchase consideration over the net tangible and identifiable
intangible assets acquired of $344.9 million. The following unaudited condensed
balance sheet data presents the preliminary fair value of the assets and
liabilities acquired and recorded at June 6, 2002.
(IN THOUSANDS)
Assets acquired
Cash, cash equivalents and short-term investments $ 241,313
Accounts receivable 67,154
Prepaid expenses and other current assets 19,483
Assets held for sale 33,220
Intangible assets 365,000
Goodwill 344,949
Other assets 3,876
----------------
Total assets acquired $1,074,995
================
Liabilities acquired
Accounts payable and accrued liabilities $ 172,528
Deferred revenue 30,080
Income taxes payable 94,576
Other liabilities 4,651
----------------
Total liabilities acquired $ 301,835
================
Other current assets acquired includes an investment in a venture-capital
fund valued at $12.8 million. Management intends to dispose of this investment;
however, the Company has been unable to obtain certain financial records and
information required to effectively market the investment. The fair value of the
asset recorded does not include any adjustment of this investment due to this
contingency. Any adjustment to the fair-value of this investment that is
ultimately made will increase or decrease the purchase consideration and the
allocation of the purchase consideration to goodwill.
29
UNAUDITED PRO FORMA RESULTS OF OPERATIONS. The following table presents pro
forma results of operations and gives effect to the proposed merger as if the
merger had been consummated on November 1, 2000. The unaudited pro forma results
of operations are not necessarily indicative of the results of operations had
the acquisition actually occurred at the beginning of fiscal 2001, nor is it
necessarily indicative of future operating results:
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
-------------- -------------- ------------ ------------
Revenues $ 278,217 $ 276,922 $ 861,822 $ 789,308
Net income (loss) 16,099 18,434 71,697 (188,593)
Basic earnings (loss) per share $ 0.23 $ 0.25 $ 1.12 $ (2.50)
Weighted average common shares outstanding 71,157 74,578 64,157 75,580
Diluted earnings (loss) per share $ 0.21 $ 0.23 $ 1.04 $ (2.50)
Weighted average common shares and dilutive stock
options outstanding 71,157 80,351 64,157 75,580
The unaudited pro forma results of operations for each of the periods
presented exclude non-recurring merger costs of $95,000 and $82,500 for the
contingently refundable insurance policy and IPRD recorded by Synopsys in the
third quarter of 2002 and included in the historical condensed consolidated
statement of operations.
GOODWILL AND INTANGIBLE ASSETS. Goodwill, representing the excess of the
purchase price over the fair value of tangible and identifiable intangible
assets acquired in the merger will not be amortized consistent with the guidance
with SFAS 142. The goodwill associated with the Avant! acquisition is not
deductible for tax purposes. In addition, a portion of the purchase price was
allocated to the following identifiable intangible assets:
Intangible Asset (IN THOUSANDS) Estimated Useful Life
- ----------------------------------------- ----------------- ----------------------------------------------------
Core/developed technology $184,000 3 years
Contract rights intangible 51,700 3 years
Customer installed base/relationship 102,500 6 years
Trademarks and tradenames 17,700 3 years
Covenants not to compete 9,100 The life of the related agreement (2 to 4 years)
-----------------
Total $365,000
=================
CONTRACT RIGHTS INTANGIBLE. Avant! had executed signed license agreements
and delivered the initial configuration of licensed technologies under ratable
license arrangements, had executed signed contracts to provide PCS over a one to
three year period, for which Avant! did not consider the fees to be fixed and
determinable at the outset of the arrangement. There were no receivables or
deferred revenues recorded on Avant!'s historical financial statements at the
closing date as the related payments were not yet due under extended payment
terms and deliveries are scheduled to occur over the term of the arrangements.
These ratable licenses and PCS arrangements require future performance by both
parties and, as such, represent executory contracts. The contract rights
intangible asset associated with these arrangements is amortized to cost of
revenue over the related contract lives.
The amortization of intangible assets, with the exception of the contract
rights intangible and core/developed technology, is included in operating
expenses in the statement of operations for the three- and nine-month periods
ended July 31, 2002. Amortization of core/developed technology is included in
cost of revenue.
ASSET HELD FOR SALE. In January 2001, Synopsys sold the assets of its
silicon libraries business to Artisan Components, Inc. ("Artisan") and entered
into an agreement not to engage, directly or indirectly, in the physical
libraries business before January 3, 2003. Synopsys also agreed that if it
acquired a physical libraries business as part of a larger acquisition, then
Artisan would have certain preferential rights to negotiate and bid for such
business. Prior to the merger, Avant! engaged in the physical libraries
business. As a result of the merger, Synopsys acquired Avant!'s physical
libraries business, and Synopsys is obligated to offer and sell such business to
Artisan under the terms of the January 2001 agreement. The value allocated to
30
the acquired libraries business has been recorded as net assets held for sale
and is based on the estimated future net cash flows from the libraries business
in accordance with EITF 87-11, ALLOCATION OF PURCHASE PRICE TO ASSETS TO BE
SOLD. The carrying value of the libraries business as of July 31, 2002 is
approximately $33.1 million and losses for the period from June 6, 2002 through
July 31, 2002 that have been excluded from the consolidated income statement
were approximately $0.5 million.
CADENCE LITIGATION. Avant! and its subsidiaries are engaged in the
Avant!/Cadence litigation, a material civil litigation matter. The
Avant!/Cadence litigation generally arises out of the same set of facts that
were the subject of a criminal action brought against Avant! and several
individuals by the District Attorney of Santa Clara
County, California, which action we refer to as the Santa Clara criminal action.
Avant!, Gerald C. Hsu, Chairman of Avant! and five former Avant! employees pled
no contest to certain of the charges in the Santa Clara criminal action. As part
of that plea, Avant! paid approximately $35.3 million in fines and a hearing was
held on the amount of restitution owed to Cadence. During the hearing, Cadence
claimed losses of $683.3 million. Ultimately, the court in the Santa Clara
criminal action required Avant! to pay Cadence restitution in the amount of
$195.4 million. That amount has been fully paid.
Cadence seeks compensatory damages and treble or other exemplary damages
from Avant! in the Avant!/Cadence litigation under theories of copyright
infringement, misappropriation of trade secrets, inducing breach of contract and
false advertising. Synopsys believes Avant! has defenses to all of Cadence's
claims in the Avant!/Cadence litigation. Cadence has not fully quantified the
amount of damages it seeks in the Avant!/Cadence litigation. Should Cadence
ultimately succeed in the prosecution of its claims, however, Avant! could be
required to pay substantial monetary damages to Cadence. Some or all of these
damages may be offset by the $195.4 million restitution paid to Cadence in the
Santa Clara criminal action. Approximately $500 million in additional damages
would be covered by the insurance policy Synopsys has obtained with respect to
the Avant!/Cadence litigation, which is described below.
Injunctions entered in 1997 and 1998 enjoined Avant! from marketing its
early place and route products, ArcCell and Aquarius, based on a judicial
determination that they incorporated portions of Cadence's Design Framework II
source code (DFII). The injunctions also prohibit Avant! from possessing, using,
selling or licensing any product or work copied or derived from DFII and
directly or indirectly marketing, selling leasing, licensing, copying or
transferring any of the ArcCell or Aquarius products. Avant! ceased marketing,
selling, leasing, licensing or supporting all of the ArcCell or Aquarius
products in 1996 and 1999, respectively. The DFII code is not incorporated in
any current Avant! product. Although Cadence has not made a claim in the
Avant!/Cadence litigation against any current Avant! product, including its
Apollo and Astro place and route products, and has not introduced any evidence
that any such product infringes Cadence's intellectual property rights, Cadence
has publicly implied that it intends to assert such claims. Synopsys believes it
would have defenses to any such claims. Nonetheless, should Cadence be
successful at proving that any past or then-current Avant! product incorporated
intellectual property misappropriated from Cadence, Synopsys could be
permanently enjoined from further use of such intellectual property, which might
require modification to existing products and/or suspension of the sale of such
products until such Cadence intellectual property was removed.
In connection with the merger, Synopsys has entered into a policy with a
subsidiary of American International Group, Inc., a AAA-rated insurance company,
whereby insurance has been obtained for certain compensatory, exemplary and
punitive damages, penalties and fines and attorneys' fees arising out of pending
litigation between Avant! and Cadence. The policy does not provide coverage for
litigation other than the Avant!/Cadence litigation.
The Company paid total premium of $335 million for the policy, of which $240
million is contingently refundable. Under the policy the insurer is obligated to
pay covered loss up to a limit of liability equaling (a) $500 million plus (b)
interest accruing at the fixed rate of 2%, compounded semi-annually, on $250
million (the "interest component"), as reduced by previous covered losses. The
policy will expire following a final judgment or settlement of the
Avant!/Cadence litigation or any earlier date upon Synopsys' election. Upon such
expiration, Synopsys will be entitled to a payment equal to $240 million plus
the interest component less any covered loss (which, for this purpose, shall
include legal fees only to the extent that the aggregate amount of such fees
exceeds $10 million).
The contingently refundable portion of the insurance premium ($240 million)
is included in the July 31, 2002 balance sheet as a long-term restricted asset.
Interest earned on $250 million will be included in other income, net in the
post-merger statement of operations. The balance of the premium paid to the
insurer ($95 million) is included in integration expense for the three- and
nine-month periods ended July 31, 2002.
At the closing date, the Avant!/Cadence litigation was accounted for as a
pre-merger contingency because a litigation judgment or settlement amount, if
any, is not probable or estimable. If a litigation loss becomes probable and
estimable after the date of the merger, such loss will be included in net
income.
31
INTEGRATION COSTS. Non-recurring integration costs incurred by the Company
relate to merger activities which are not included in the purchase consideration
under EITF 95-3. These costs are expensed as incurred. During the third quarter
of 2002, integration costs totaled $117.3 million. These costs consisted
primarily of (i) a premium of $95.0 million related to the contingently
refundable insurance policy, (ii) $14.7 million related to write-downs of
Synopsys facilities and property under the approved facility exit plan, (iii)
severance costs for Synopsys employees who were terminated as a result of the
merger and costs associated with transition employees totaled $6.2 million, and
(iv) $1.3 million related to the write-off of software licenses owned by
Synopsys which were originally purchased from Avant!.
VALUATION OF IPRD. Upon consummation of the Avant! merger, the Company
immediately recognized expense of $82.5 million representing the value of the
acquired in-process technology for which technological feasibility had not been
achieved and no alternative future uses had been established. The value assigned
to acquired in-process technology was determined by identifying products under
research in areas for which technological feasibility had not been established.
The in-process technology was then segmented into two classifications: (i)
in-process technology -- completed and (ii) in-process technology --
to-be-completed, giving explicit consideration to the value created by the
research and development efforts of the acquired business prior to the
acquisition and to be created by Synopsys after the acquisition. These value
creation efforts were estimated by considering the following major factors: (i)
time-based data, (ii) cost-based data and (iii) complexity-based data.
The value of the in-process technology was determined using a discounted
cash flow model similar to the income approach, focusing on the income-producing
capabilities of the in-process technologies. Under this approach, the value is
determined by estimating the revenue contribution generated by each of the
identified products classified within the classification segments. Revenue
estimates were based on (i) individual product revenues, (ii) anticipated growth
rates (iii) anticipated product development and introduction schedules (iv)
product sales cycles, and (v) the estimated life of a product's underlying
technology. From the revenue estimates, operating expense estimates, including
costs of sales, general and administrative, selling and marketing, income taxes
and a use charge for contributory assets, were deducted to arrive at operating
income. Revenue growth rates were estimated by management for each product and
gave consideration to relevant market sizes and growth factors, expected
industry trends, the anticipated nature and timing of new product introductions
by us and our competitors, individual product sales cycles, and the estimated
life of each product's underlying technology. Operating expense estimates
reflect Synopsys' historical expense ratios. Additionally, these projects will
require continued research and development after they have reached a state of
technological and commercial feasibility. The resulting operating income stream
was discounted to reflect its present value at the date of the acquisition.
These estimates are subject to change, given the uncertainties of the
development process, and no assurance can be given that deviations from these
estimates will not occur or that Synopsys will realize any anticipated benefits
of the acquisition.
The rate used to discount the net cash flows from purchased in-process
technology is the weighted average cost of capital (WACC) for the Company,
taking into account its required rates of return from investments in various
areas of the enterprise, and reflecting the inherent uncertainties in future
revenue estimates from technology investments including the uncertainty
surrounding the successful development of the acquired in-process technology,
the useful life of such technology, the profitability levels of such technology,
if any, and the uncertainty of technological advances, all of which are unknown
at this time.
At the date of the Avant! merger, the principal in-process technologies were
identified based on the following product families: PPD Division, VPD Division,
APD Division, LPD Division, MTB, TCAD and Analogy. For purposes of valuing the
IPRD in accordance with the methodology discussed above, the following estimates
were used: revenue growth ranging from 16% in year two to 10% in year nine; cost
of sales -- 7% of revenue in each year; general and administrative expenses --
5% of revenue in each year; and sales and marketing -- 28% of revenue in each
year. In addition, it was assumed there would be no expense reduction due to
economic synergies as a result of the acquisition. The rate used to discount the
net cash flows from the purchased in-process technology was 27%. The
technologies were approximately 40% to 90% complete at the acquisition date. The
nature of the efforts to complete these projects related, in varying degrees, to
the completion of all planning, designing, prototyping, verification, and
testing activities that are necessary to establish that the proposed
technologies met their design specifications, including functional, technical,
and economic performance requirements. Expenditures to complete the acquired
in-process technologies are expected to total approximately $17.5 million.
ACQUISITION OF INSILICON CORPORATION. On July 23, 2002, we entered into an
Agreement and Plan of Merger with inSilicon Corporation (inSilicon) under which
we commenced a cash tender offer to acquire all of the outstanding shares of
inSilicon common stock at $4.05 per share or approximately $64.9 million,
subject to certain conditions. Following the consummation of the tender offer,
inSilicon will merge with and into a wholly owned subsidiary of Synopsys. We
will account for the merger under the purchase method of accounting. The merger
is subject to certain conditions, including approval of the merger and the
Agreement and Plan of Merger by the inSilicon stockholders, compliance with
regulatory requirements and customary closing conditions.
32
ACQUISITION OF CO-DESIGN. On September 6, 2002, we acquired all of the
outstanding shares of capital stock of Co-Design Automation, Inc. (Co-Design)
for consideration consisting of cash and notes of $29.7 million and $4.8
million, respectively, and assumed options with an aggregate value of
approximately $1.3 million. We will account for the merger under the purchase
method of accounting. As of the date of filing the Form 10-Q, the valuation of
Co-Design's assets and liabilities, including identifiable intangible assets, as
of the closing date has not been completed. We purchased Co-Design for a number
of reasons, including (i) the combination of Co-Design's technology with our
verification tools is expected to speed the delivery of next-generation hardware
description language solutions; (ii) the acquisition will help promote the use
of the Superlog language, which we believe will be important in developing next
generation verification tools and increasing designer productivity; and (iii)
the acquisition gives us access to Co-Design's industry experts. As of the date
of filing the Form 10-Q, the valuation of Co-Design's assets and liabilities,
including identifiable intangible assets, as of the closing date has not been
completed.
EFFECT OF NEW ACCOUNTING STANDARDS. In July 2001, the Financial Accounting
Standards Board (FASB) issued Statements of Financial Accounting Standards No.
141, BUSINESS COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
and specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized apart from goodwill. SFAS 142 requires
that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually in accordance
with the provisions of SFAS 142.
The Company adopted the provisions of SFAS 141 on July 1, 2001. Under SFAS
141, goodwill and intangible assets with indefinite useful lives acquired in a
purchase business combination completed after June 30, 2001, but before SFAS 142
is adopted, will not be amortized but will continue to be evaluated for
impairment in accordance with SFAS 121. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized and tested for impairment in accordance with current accounting
guidance until the date of adoption of SFAS 142.
Upon adoption of SFAS 142, the Company must evaluate its existing intangible
assets and goodwill acquired in purchase business combinations prior to July 1,
2001, and make any necessary reclassifications in order to conform with the new
criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS
142, the Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments. The Company will also be required to test goodwill for
impairment in accordance with the provisions of SFAS 142 within the six-month
period following adoption. Any impairment loss will be measured as of the date
of adoption and recognized immediately as the cumulative effect of a change in
accounting principle. Any subsequent impairment losses will be included in
operating activities.
The Company expects to adopt SFAS 142 on November 1, 2002. As of July 31,
2002, unamortized goodwill is $23.1 million which, in accordance with the
Statements, will continue to be amortized until the date of adoption of SFAS
142. Amortization of goodwill and other intangible assets for the nine-month
period ended July 31, 2002 is $12.1 million. Goodwill totaling $344.9 relates to
acquisitions subsequent to July 1, 2001 and is therefore not amortized in
accordance with FAS 142. The Company does not have any intangible assets with an
indefinite useful life. The Company is currently evaluating the impact of the
adoption of this statement on its financial position and results of operations.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS (SFAS 143). SFAS 143
requires that asset retirement obligations that are identifiable upon
acquisition, construction or development and during the operating life of a
long-lived asset be recorded as a liability using the present value of the
estimated cash flows. A corresponding amount would be capitalized as part of the
asset's carrying amount and amortized to expense over the asset's useful life.
The Company is required to adopt the provisions of SFAS 143 effective November
1, 2002. The adoption of SFAS 143 will not have a significant impact on the
company's financial position and results of operations.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS (SFAS
144), which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and
the accounting and reporting provisions of APB Opinion No. 30, REPORTING THE
RESULTS OF OPERATIONS FOR A DISPOSAL OF A SEGMENT OF A BUSINESS. The Company is
33
required to adopt the provisions of SFAS 144 no later than November 1, 2002. The
Company does not expect that the adoption of SFAS 144 will have a significant
impact on its financial position and results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB
STATEMENT NO. 13, AND TECHNICAL CORRECTIONS (SFAS 145). SFAS 145 eliminates the
requirement that gains and losses from the extinguishments of debt be aggregated
and, if material, classified as an extraordinary item, net of the related income
tax effect. However, an entity would not be prohibited from classifying such
gains and losses as extraordinary items so long as they are both unusual in
nature and infrequent in occurrence. The Company is required to adopt the
provisions of SFAS 145 effective November 1, 2002. SFAS 145 also amends SFAS 13,
ACCOUNTING FOR LEASES and certain other authoritative pronouncements to make
technical corrections or clarifications. SFAS 145 will be effective related to
the amendment of SFAS 13 for all transactions occurring after May 15, 2002. The
Company does not expect that the adoption of SFAS 145 will have a significant
impact on its financial position and results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES. SFAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits that
employees who are involuntarily terminated receive under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING) and requires liabilities associated with exit and disposal
activities to be expensed as incurred. SFAS 146 will be effective for exit or
disposal activities of the Company that are initiated after December 31, 2002.
The Company believes that the adoption of SFAS 146 will not have a significant
impact on its financial position and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments were $446.2 million at
July 31, 2002, a decrease of $30.2 million, or 6%, from October 31, 2001. Cash
used in operating activities was $78.1 million for the nine months ended July
31, 2002 compared to $123.4 million provided by operating activities for the
same period in the prior year. The decrease in cash flows from operating
activities is due primarily to payments for income taxes made during the first
quarter, payments made for the insurance premium, professional fees, severance
and integration of Avant! as well as a payment to settle pending litigation.
Cash provided by investing activities was $94.3 million and $110.8 million
in the first nine months of 2002 and 2001, respectively. This decrease in cash
provided by investing activities relates primarily to the purchase of a
contingently refundable insurance policy relating to the Avant!/Cadence
litigation, totaling $240.0 million, the effect of which was partially offset by
the cash received from Avant! on the closing date, totaling $235.0 million. Net
proceeds from the sale of short- and long-term investments totaled $136.4
million for the nine months ended July 31, 2002 compared to net proceeds of
investments totaling $159.6 million for the same period during 2001. Capital
expenditures decreased $16.1 to $35.9 million for the nine-months ended July 31,
2002 from $52.0 million during the same period in fiscal 2001 due to the
expenditures related to construction of our Oregon facilities and computing
equipment to upgrade our infrastructure systems incurred during fiscal 2001. In
addition, cash proceeds from the sale of our silicon libraries business were
$4.1 million in the first quarter of fiscal 2001.
Cash provided by financing activities was $61.8 million for the nine months
ended July 31, 2002 compared to $249.0 million used in financing activities
during the same period during fiscal 2001. Financing proceeds from the exercise
of stock options during the nine months ended July 31, 2002 and 2001 were $103.6
million and $89.3 million, respectively. The primary financing uses of cash
during the nine months ended July 31, 2002 and 2001 were for the purchase of
treasury stock, net of reissuances, totaling $41.8 million and $331.9 million,
respectively.
Accounts receivable increased to $233.2 million at July 31, 2002 compared to
$146.3 million at October 31, 2001. Days sales outstanding, which is calculated
based on revenues for the most recent quarter and accounts receivable as of the
balance sheet date, increased to 85 days as of July 31, 2002 from 73 days at
October 31, 2001 as a result of an increase in accounts receivable due to the
Avant! acquisition.
Our principle sources of cash are collections of accounts receivable and the
issuance of common stock. During fiscal 2002 we have increasingly agreed to
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extended payment terms on our TSLs, which has had a negative effect on cash flow
from operations. Since the middle of last year to this past quarter, the
percentage of cash scheduled to be collected within 60 days of the order has
moved from approximately 65% to approximately 22%, and the percentage of cash
scheduled to be collected within one year has moved from approximately 88% to
66%. We believe that our current cash, cash equivalents, short-term investments,
lines of credit, and cash generated from operations will satisfy our business
requirements for at least the next twelve months.
FACTORS THAT MAY AFFECT FUTURE RESULTS
WEAKNESS IN THE SEMICONDUCTOR AND ELECTRONICS BUSINESSES MAY NEGATIVELY
IMPACT SYNOPSYS' BUSINESS. Synopsys' business depends on the semiconductor and
electronics businesses. In 2001, these businesses experienced their sharpest
decline in orders and revenue in over 20 years and this weakness has continued
in 2002.
Purchases of our products are largely dependent upon the commencement of new
design projects by semiconductor manufacturers and their customers, the number
of design engineers and the increasing complexity of designs. During 2001 many
semi-conductor and electronic companies cancelled or deferred design projects
and reduced their design engineering staffs, which negatively impacted our
orders and revenues, particularly orders and revenues from our professional
services business. Demand for our products and services may also be affected by
partnerships and/or mergers in the semiconductor and systems industries, which
may reduce the aggregate level of purchases of our products and services by the
companies involved. Continuation or worsening of the current conditions in the
semiconductor industry, and continued consolidation among our customers, all
could have a material adverse effect on our business, financial condition and
results of operations.
SYNOPSYS' REVENUE AND EARNINGS MAY FLUCTUATE. Many factors affect our
revenue and earnings, which makes it difficult to achieve predictable revenue
and earnings growth. Among these factors are customer product and service
demand, product license terms, and the timing of revenue recognition on products
and services sold. The following specific factors could affect our revenue and
earnings in a particular quarter or over several quarterly or annual periods:
o Our products are complex, and before buying them customers spend a great
deal of time reviewing and testing them. Our customers' evaluation and
purchase cycles do not necessarily match our quarterly periods. In the
past, we have received a disproportionate volume of orders in the last week
of a quarter, and this trend has become more pronounced in recent quarters.
In addition, a large proportion of our business is attributable to our
largest customers. As a result, if any order, and especially a large order,
is delayed beyond the end of a fiscal period, our orders for that period
could be below our plan and our revenue for that period or future periods
could be below any targets we may have published.
o Accounting rules determine when revenue is recognized on our orders, and
therefore impact how much revenue we will report in any given fiscal
period. The authoritative literature under which Synopsys recognizes
revenue has been, and is expected to continue to be, the subject of much
interpretative guidance. In general, revenue is recognized on TSLs ratably
over the term of the license and on perpetual licenses upon delivery of the
license. For any given order, however, the specific terms agreed to with a
customer may have the effect under the accounting rules of requiring
revenue treatment different from the treatment we intended and, in
developing our financial plans, expected. Therefore, for any given fiscal
period it is possible for us to fall short in our revenue and/or earnings
plan even while orders and backlog remain on plan or, conversely, to meet
or exceed our revenue and/or earnings plan because of backlog and deferred
revenue, while aggregate orders are under plan.
o Our revenue and earnings targets are based, in part, upon an assumption
that we will achieve a license mix of perpetual licenses (on which revenue
is generally recognized in the quarter shipped) and TSLs (on which revenue
is recognized over the term of license) within a specified range, which is
adjusted from time to time. If we are unable to achieve a mix in this range
our ability to achieve short-term or long-term revenue and/or earnings
targets may be impaired.
SYNOPSYS MAY NOT BE ABLE TO SUCCESSFULLY COMPETE IN THE EDA INDUSTRY, WHICH
WOULD HAVE A MATERIAL ADVERSE EFFECT ON SYNOPSYS' RESULTS OF OPERATIONS. The EDA
industry is highly competitive. We compete against other EDA vendors, and with
customers' internally developed design tools and internal design capabilities
for a share of the overall EDA budgets of our potential customers. In general,
competition is based on product quality and features, post-sale support, price,
payment terms and, as discussed below, the ability to offer a complete design
flow. Our competitors include companies that offer a broad range of products and
35
services, such as Cadence Design Systems, Inc. and Mentor Graphics Corporation,
as well as companies, including numerous recently public and start-up companies,
that offer products focused on a discrete phase of the integrated circuit design
process. In the current economic environment price and payment terms have
increased in importance as a basis for competition. During fiscal 2002 we have
increasingly agreed to extended payment terms on our TSLs, which has had a
negative effect on cash flow from operations. In addition, in certain situations
our competitors are offering aggressive discounts on their products. As a
result, average prices may fall.
IF WE ARE UNABLE TO DEVELOP AN INTEGRATED DESIGN FLOW PRODUCT AND OTHER NEW
PRODUCTS WE MAY BE UNABLE TO COMPETE EFFECTIVELY Increasingly, EDA companies
compete on the basis of design flows involving integrated logic and physical
design products rather than on the basis of individual point tools performing a
discrete phase of the design process. The need to offer an integrated design
flow will become increasingly important as ICs grow more complex. After the
acquisition of Avant! we offer all of the point tools required to design an IC,
some of which integrate logic and physical design capabilities. Our products
compete principally with design flow products from Cadence and Magma Design
Automation, which are in some respects more integrated than our products. Our
future success depends on our ability to integrate Synopsys' logic design and
physical synthesis products with the physical design products acquired from
Avant!, which will require significant engineering and development work. There
can be no guarantee that we will be able to offer a competitive complete design
flow to customers. If we are unsuccessful in developing integrated design flow
products on a timely basis or if we are unsuccessful in developing or convincing
customers to adopt such a such products, our competitive position could be
significantly weakened.
In order to sustain revenue growth over the long term, we will have to
enhance our existing products, introduce new products that are accepted by a
broad range of customers and to generate growth in our consulting services
business. Product success is difficult to predict. The introduction of new
products and growth of a market for such products cannot be assured. In the past
we, like all companies, have introduced new products that have failed to meet
our revenue expectations. Expanding revenue from consulting services may be
difficult in the current economic environment. Increasing consulting orders and
revenue while maintaining an adequate level of profit can be difficult. There
can be no assurance that we will be successful in expanding revenue from
existing or new products at the desired rate or in expanding our services
business, and the failure to do so would have a material adverse effect on our
business, financial condition and results of operations.
SYNOPSYS MAY FAIL TO INTEGRATE SUCCESSFULLY SYNOPSYS' AND AVANT!'S
OPERATIONS. AS A RESULT, SYNOPSYS MAY NOT ACHIEVE THE ANTICIPATED BENEFITS OF
THE ACQUISITION. Achieving the benefits of our acquisition of Avant! will depend
on many factors, including the successful and timely integration of the
products, technology and sales operations of the two companies. These
integration efforts may be difficult and time consuming, especially considering
the highly technical and complex nature of each company's products. Failure to
achieve a successful and timely integration of the Synopsys and Avant! products
and sales operations could result in the loss of existing or potential customers
of Synopsys and Avant! and could have a material adverse effect on our business,
financial condition and results of operations. Integration efforts will also
divert significant management attention and resources. This diversion of
attention and resources could have an adverse effect on Synopsys during such
transition period.
OTHER BUSINESSES THAT SYNOPSYS HAS ACQUIRED OR THAT SYNOPSYS MAY ACQUIRE IN
THE FUTURE MAY NOT PERFORM AS PROJECTED. We have acquired or merged with a
number of companies in recent years, and as part of our efforts to increase
revenue and expand our product and services offerings we may acquire additional
companies. In addition to acquiring Avant!, in July 2002, we announced an
agreement to acquire inSilicon Corporation and in September 2002 we completed
the acquisition of Co-Design Automation, Inc. In addition to direct costs,
acquisitions pose a number of risks, including potential dilution of earnings
per share, problems in integrating the acquired products and employees into our
business, the failure to realize expected synergies or cost savings, the failure
of acquired products to achieve projected sales, the drain on management time
for acquisition-related activities, adverse effects on customer buying patterns
and assumption of unknown liabilities. While we attempt to review proposed
acquisitions carefully and negotiate terms that are favorable to us, there is no
assurance that any acquisition will have a positive effect on our performance.
CONTINUED STAGNATION OF INTERNATIONAL ECONOMIES WOULD ADVERSELY AFFECT OUR
PERFORMANCE. During the three and nine months ended July 31, 2002, 35% of our
revenue was derived from outside North America, as compared to 37% and 38%
during the same periods in fiscal 2001, respectively. International sales are
vulnerable to regional or worldwide economic or political conditions and to
changes in foreign currency exchange rates. Economic conditions in Europe and
Japan have been stagnant for several quarters, and the longer this weakness
persists the more likely it is to have a negative impact on our business. In
particular, a number of our largest European customers are in the
telecommunications equipment business, which has weakened considerably. The
Japanese economy has been stagnant for several years, and there is no
expectation of improvement in the near future. If the Japanese economy remains
36
weak, revenue and orders from Japan, and perhaps the rest of Asia, could be
adversely affected. In addition, the yen-dollar and Euro-dollar exchange rates
remain subject to unpredictable fluctuations. Weakness of either currency could
adversely affect revenue and orders from those regions. Asian countries other
than Japan also have experienced economic and currency problems in recent years,
and in most cases they have not fully recovered. Although the Asia Pacific
region is growing it is relatively small as a percentage of our business and it
could be difficult to sustain growth in the region if the rest of the world's
economies continue to stagnate. If economic conditions worsen orders and
revenues from the Asia Pacific region would be adversely affected.
AVANT! MAY BE REQUIRED TO PAY SUBSTANTIAL AMOUNTS UNDER PENDING CIVIL
LITIGATION. Avant! is a defendant in litigation brought by Cadence (the
Avant!/Cadence litigation) in which Cadence seeks compensatory damages and
treble or other exemplary damages under theories of copyright infringement,
misappropriation of trade secrets, inducing breach of contract and false
advertising. As part of the proceeding, in 1997 and 1998 Avant! was enjoined
from marketing two products based on a judicial determination that they
incorporated certain Cadence intellectual property. In July 2001 Avant!, Gerald
C. Hsu, former Chairman of Avant!, and five former Avant! employees pled no
contest to certain criminal charges based on generally the same set of facts. As
part of that plea, Avant! paid fines of approximately $35 million and paid
restitution to Cadence of approximately $195 million. Cadence has not fully
quantified the amount of damages it seeks in the Avant!/Cadence litigation, nor
has it made a claim against any existing product, although it has publicly
implied that it intends to assert such claims. Synopsys believes Avant! has
defenses to any Cadence claims. Should Cadence's claims ultimately succeed,
however, Avant! could be required to pay substantial monetary damages to
Cadence. Some or all of these damages may be offset by the $195 million
restitution already paid to Cadence, and approximately $500 million in damages
(over and above whatever amount is subject to offset by the restitution payment)
owed by Synopsys would be paid by litigation insurance obtained by Synopsys. See
"Cadence Litigation". Should Cadence be successful at proving that any current
product incorporated intellectual property misappropriated from Cadence, Avant!
and Synopsys could be permanently enjoined from further use of such intellectual
property. To the extent that damages owed to Cadence exceeded the any offset
plus the proceeds from the insurance policy, or that Synopsys is precluded from
using any intellectual property acquired from Avant! and in use at the time of a
judgment and is unable to develop a suitable replacement for such intellectual
property, the Avant!/Cadence litigation could have a material adverse effect on
Synopsys' business, financial condition and results of operation.
THE INSURER UNDER THE LITIGATION INSURANCE MAY BE PREVENTED FROM PAYING FOR
CERTAIN LOSSES ON THE GROUNDS THAT SUCH PAYMENT VIOLATES PUBLIC POLICY. Synopsys
has obtained litigation insurance issued by a subsidiary of American
International Group, Inc., an insurance company rated AAA by Standard & Poors.
See "Litigation". In some jurisdictions, it is against public policy to provide
insurance for willful acts, punitive damages or similar claims. This could
potentially affect the validity and enforceability of certain elements of the
litigation insurance. The legal agreement governing the litigation insurance
expressly provides that the agreement will be governed by the laws of the State
of Delaware and that any disputes arising out of or relating to the agreement
will be resolved in the courts of the State of Delaware. Synopsys believes,
based upon advice it has received from Delaware counsel, that a Delaware court
would enforce both of these provisions, and moreover would enforce the
arrangement under Delaware law, including to the extent it provides for
insurance for Avant!'s willful acts and punitive damages. Nonetheless, there can
be no assurance in this regard. In other cases, courts, including courts in
California, have applied local law to insurance contracts irrespective of the
parties' choice of law. Thus a court in a state other than Delaware could assert
jurisdiction over the enforceability of this agreement and rule pursuant to the
law of a state other than Delaware that the litigation protection insurance is
not enforceable in whole or in part on grounds of public policy. For example, if
there were to be litigation before a California court regarding the
enforceability of the insurance policy it is possible that a California court
might rule that the enforceability of the litigation protection insurance should
be governed by California law, despite the parties' agreement that all disputes
arising out of or relating to the agreement be resolved in the courts of the
State of Delaware, and that California law prevents certain payments under the
policy. A Delaware court might abide by such a ruling of a California court. To
the extent the insurer is prevented from paying certain losses on grounds of
public policy that would otherwise be covered by the insurance, Avant! will be
required to pay that portion of the losses and the insurer may be obligated to
refund a portion of the premium to Synopsys.
SYNOPSYS DOES NOT HAVE CONTROL OVER DEFENSE OF THE AVANT!/CADENCE LITIGATION
OR THE AUTHORITY TO SETTLE THE AVANT!/CADENCE LITIGATION EXCEPT IN LIMITED
CIRCUMSTANCES. Under the terms of the litigation insurance, the insurer has the
right to exercise full control over the defense of the Avant!/Cadence
litigation, and the right to exclusively control the negotiation, discussion and
terms of any proposed settlement, except that (i) Synopsys retains the right to
settle the Avant!/Cadence litigation, with the consent of the insurer, for up to
$250 million plus accrued interest less certain costs, and (ii) Synopsys and the
defendants in the Avant!/Cadence litigation each retain the right to consent or
37
reasonably withhold consent to any settlement terms proposed by the insurer
which are non-monetary and can be satisfied only by future performance or
non-performance by Synopsys or such defendants, as the case may be. Therefore,
Synopsys has a severely limited ability to control the strategy and tactics
adopted with respect to the litigation and may be subject to certain risks and
liabilities relating to the defense and/or potential settlement of such
litigation.
A FAILURE TO RECRUIT AND RETAIN KEY EMPLOYEES WOULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR ABILITY TO COMPETE. Our success is dependent on technical and
other contributions of key employees. We participate in a dynamic industry, and
our headquarters is in Silicon Valley, where, despite recent economic
conditions, skilled technical, sales and management employees are in high
demand. There are a limited number of qualified EDA and IC design engineers, and
the competition for such individuals is intense. Despite economic conditions,
start-up activity in EDA remains significant. Experience at Synopsys is highly
valued in the EDA industry and the general electronics industry, and our
employees, including employees that joined Synopsys in the Avant! merger, are
recruited aggressively by our competitors and by start-up companies in many
industries. In the past, we have experienced, and may continue to experience,
significant employee turnover. There can be no assurance that we can continue to
recruit and retain the technical and managerial personnel we need to run our
business. Failure to do so could have a material adverse effect on our business,
financial condition and results of operations.
A FAILURE TO PROTECT OUR PROPRIETARY TECHNOLOGY WOULD HAVE A MATERIAL
ADVERSE EFFECT ON SYNOPSYS' FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Our
success is dependent, in part, upon our proprietary technology and other
intellectual property rights. We rely on agreements with customers, employees
and others, and intellectual property laws, to protect our proprietary
technology. There can be no assurance that these agreements will not be
breached, that we would have adequate remedies for any breach or that our trade
secrets will not otherwise become known or be independently developed by
competitors. Moreover, effective intellectual property protection may be
unavailable or limited in certain foreign countries. Failure to obtain or
maintain appropriate patent, copyright or trade secret protection, for any
reason, could have a material adverse effect on our business, financial
condition and results of operations. In addition, there can be no assurance that
infringement claims will not be asserted against us and any such claims could
require us to enter into royalty arrangements or result in costly and
time-consuming litigation or could subject us to damages or injunctions
restricting our sale of products or could require us to redesign products.
OUR OPERATING EXPENSES DO NOT FLUCTUATE PROPORTIONATELY WITH FLUCTUATIONS IN
REVENUES, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS IN
THE EVENT OF A SHORTFALL IN REVENUE. Our operating expenses are based in part on
our expectations of future revenue, and expense levels are generally committed
in advance of revenue. Since only a small portion of our expenses varies with
revenue, a shortfall in revenue translates directly into a reduction in net
income. If we are unsuccessful in generating anticipated revenue or maintaining
expenses within this range, however, our business, financial condition and
results of operations could be materially adversely affected.
SYNOPSYS HAS ADOPTED ANTI-TAKEOVER PROVISIONS, WHICH MAY HAVE THE EFFECT OF
DELAYING OR PREVENTING CHANGES OF CONTROL OR MANAGEMENT. We have adopted a
number of provisions that could have anti-takeover effects. Our Board of
Directors has adopted a Preferred Shares Rights Plan, commonly referred to as a
poison pill. In addition, our Board of Directors has the authority, without
further action by its stockholders, to issue additional shares of Common Stock
and to fix the rights and preferences of, and to issue authorized but
undesignated shares of Preferred Stock. These and other provisions of Synopsys'
Restated Certificate of Incorporation and Bylaws and the Delaware General
Corporation Law may have the effect of deterring hostile takeovers or delaying
or preventing changes in control or management of Synopsys, including
transactions in which the stockholders of Synopsys might otherwise receive a
premium for their shares over then current market prices.
SYNOPSYS IS SUBJECT TO CHANGES IN FINANCIAL ACCOUNTING STANDARDS, WHICH MAY
AFFECT OUR REPORTED REVENUE, OR THE WAY WE CONDUCT BUSINESS. We prepare our
financial statements in conformity with accounting principles generally accepted
in the United States of America (GAAP). GAAP are subject to interpretation by
the Financial Accounting Standards Board, the American Institute of Certified
Public Accountants (AICPA), the SEC and various bodies appointed by these
organizations to interpret existing rules and create new accounting policies. In
particular, a task force of the Accounting Standards Executive Committee, a
subgroup of the AICPA, meets on a quarterly basis to review various issues
arising under the existing software revenue recognition rules, and
interpretations of these rules. Additional interpretations issued by the task
force may have an adverse effect on how we report revenue or on the way we
conduct our business in the future.
38
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information relating to quantitative and qualitative disclosure about market
risk is set forth under the captions "Interest Rate Risk" and "Foreign Currency
Risk" in Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations. Such information is incorporated herein by reference.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Avant!, which upon completion of the Synopsys-Avant! merger became a
wholly-owned subsidiary of Synopsys, is a party to a number of material civil
litigation matters.
DESCRIPTION OF THE AVANT!/CADENCE LITIGATION. On December 6, 1995, Cadence
filed an action against Avant! and certain of its officers in the United States
District Court for the Northern District of California alleging copyright
infringement, unfair competition, misappropriation of trade secrets, conspiracy,
breach of contract, inducing breach of contract and false advertising (the
"Avant!/Cadence Litigation"). The complaint alleges that certain of Avant!'s
employees formerly employed by Cadence misappropriated and improperly copied
Cadence's Design Framework II sources code (which in this document we refer to
as "DFII") and that Avant! competed unfairly against Cadence by making false
statements about Cadence and its products. The action also alleges that Avant!
induced individuals, who were named as defendants in a criminal action filed in
December 1998, to breach their employment and confidentiality agreements with
Cadence. The same set of facts alleged in the Avant!/ Cadence litigation was
also the basis for a criminal action brought against Gerald C. Hsu, Chairman of
Avant!, and five former Avant! employees in Santa Clara County, California. In
May 2001 the defendants in that action pled no contest to certain of the
charges. As part of that plea, Avant! paid approximately $35.3 million in fines
and $195.4 million in restitution to Cadence.
In the Avant!/Cadence litigation, Cadence sought to enjoin the sale of
Avant!'s ArcCell and Aquarius place and route products. On December 19, 1997,
the District Court entered a preliminary injunction against continued sales or
licensing of any product or work copied or derived from DFII, specifically
including, but not limited to, the ArcCell products. The preliminary injunction
also bars Avant! from possessing or using any copies of any portion of the
source code or object code for ArcCell or any other product, to the extent it
had been copied or derived from DFII. Avant! had ceased licensing its ArcCell
products in mid-1996, replacing them at that time with its Aquarius products. On
December 7, 1998, the District Court also entered a preliminary injunction
against Avant! prohibiting Avant! from directly or indirectly marketing,
selling, leasing, licensing, copying or transferring the Aquarius, Aquarius XO
and Aquarius BV products. Pending the outcome of the trial of Cadence's action,
the injunction further prohibits Avant! from marketing, selling, leasing,
licensing, copying or transferring any translation code for any Aquarius product
that infringes any protected right of Cadence and prohibits Avant! from
possessing or using any copies of any portion of the source code or object code
for the Aquarius products, to the extent that it has been copied or derived from
DFII. Avant! had released its Apollo/Milkyway place and route products in
January 1998, and it ceased supporting the Aquarius products in February 1999.
In the Avant!/Cadence litigation, Cadence seeks compensatory damages and
treble or other exemplary damages from Avant!. Cadence has not fully quantified
that amount of damages it seeks in the Avant!/Cadence litigation. The press has
reported claims by Cadence representatives that Cadence may seek damages in
excess of $1 billion in the Avant!/Cadence litigation, although neither Cadence,
these representatives nor the press has ever described the basis, or provided
any substantiation, for such claims, including whether such claimed damages
include punitive damages. In the Santa Clara criminal action, Cadence claimed
losses of $683.3 million. The court in the Santa Clara criminal action
ultimately awarded Cadence $195.4 million, which included $143.5 million as
Cadence's estimated lost gross profit from all Avant! sales of ArcCell and
Aquarius products after a 1994 written release between Cadence and Avant!.
Avant! subsequently paid the entire restitution amount in full. Under California
law, Avant! may be entitled to credit that amount against any judgment Cadence
obtains in the Avant!/Cadence civil litigation.
On January 16, 1996, Avant! filed an answer to the complaint denying
wrongdoing. On the same day, Avant! filed a counterclaim against Cadence and its
then-CEO, Joseph Costello, alleging antitrust violations, racketeering, false
advertising, defamation, trade libel, unfair competition, unfair trade
39
practices, negligent and intentional interference with prospective economic
advantage, and intentional interference with contractual relations. The
counterclaim alleges, among other things, that Cadence's lawsuit is part of a
scheme to harm Avant! competitively, because of Avant!'s success in the
marketplace. Avant! filed its amended counterclaim on January 29, 1998. Pursuant
to a stipulated court order, Cadence and the other counterclaim defendants have
not responded to the amended counterclaim, and Avant!'s counterclaim is
currently stayed.
In April 1999, Avant! and Cadence filed cross-motions for summary
adjudication as to whether a 1994 written release agreement between the two
companies extinguished all Cadence claims regarding Avant!'s continued use of
intellectual property claimed by Cadence in any Avant! place and route product
in existence when the release was signed by the parties. On September 8, 1999,
the District Court granted Avant!'s motion in part and ruled that Cadence's
trade secret claim regarding use of DFII source code was barred by the release.
The District Court also ruled that the release did not bar Cadence's copyright
infringement claims regarding Avant!'s alleged post-release use of DFII source
code. Unless reversed on appeal, Avant! believes that this ruling makes it
likely that Cadence will prevail on its copyright infringement claims regarding
Avant!'s use of DFII source code in the ArcCell products. While this ruling also
increases the likelihood that Cadence will prevail on the same claims as they
might apply to the Aquarius products, Avant! believes that it possesses
additional meritorious defenses with respect to Aquarius that are not available
with respect to ArcCell. On October 15, 1999, the District Court issued an
amended order certifying its September 8, 1999 order for interlocutory appeal to
the United States Circuit Court of Appeals for the Ninth Circuit. Cadence and
Avant! petitioned for leave to file an interlocutory appeal, and the Circuit
Court granted their petitions on December 20, 1999. On June 11, 2001, the
Circuit Court certified to the California Supreme Court the following question:
Under the California Uniform Trade Secrets Act, Cal. Civ. Code sec.3426, when
does a claim for trade secret infringement arise: only once, when the initial
misappropriation occurs, or with each subsequent misuse of the trade secret? On
October 31, 2001, the California Supreme Court accepted the certified question
and on September 5, 2002, heard oral arguments. A ruling is expected before
December 5, 2002.
Proceedings in the District Court have been stayed pending the Circuit
Court's decision on appeal, which will follow the California Supreme Court's
decision on the question certified to it, and no trial date has been set.
Depending upon the timing of the decision of the California Supreme Court, the
disposition of the appeal by the Circuit Court, the discovery process, jury
selection and the judicial calendar, Avant! expects that, absent a lifting of
the current stay, any trial would likely commence no earlier than mid 2003, and
could commence substantially later.
Synopsys believes that Avant! has defenses to all of Cadence's claims and
Avant! intends to defend itself vigorously. The defenses include, but are not
limited to, Avant!'s belief that the 1994 written release bars Cadence's claims
based on the use of DFII source code. Avant!'s defenses also include Avant!'s
belief that Avant! products did not use or incorporate any Cadence proprietary
information or material allegedly misappropriated after the 1994 written
release. Should Cadence ultimately succeed in the prosecution of its claims,
however, Avant! could be required to pay substantial monetary damages to
Cadence. Some or all of these damages may be offset by the amounts paid to
Cadence as restitution arising out of the Santa Clara criminal action, as well
as by the proceeds of the litigation protection insurance policy purchased by
Synopsys to protect itself in the Avant!/Cadence litigation.
As noted above, preliminary injunctions entered in 1997 and 1998 enjoined
Avant! from marketing its early place and route products, ArcCell and Aquarius,
based on a judicial determination that they incorporated DFII source code. In
Avant!'s current place and route products the functions supported by Cadence's
DFII source code are performed by the MilkyWay database, and the DFII code is
not incorporated in any current Avant! product. Avant! developed MilkyWay under
the supervision of an independent expert employing rigorous screening and
record-keeping procedures. Cadence has never alleged that MilkyWay uses DFII
source code in any way. Although Cadence has not made a claim in the
Avant!/Cadence litigation against any current Avant! product, including its
Apollo and Astro place and route products, and has not introduced any evidence
that any such product infringes Cadence's intellectual property rights, Cadence
has publicly implied that it intends to assert such claims. If and when such
claims are made, Avant! believes it would have defenses to any such claims and
would defend itself vigorously. Nonetheless, should Cadence be successful at
proving that any past or then-current Avant! product incorporated intellectual
property misappropriated from Cadence, Avant! could be permanently enjoined from
further use of such intellectual property, which might require modification to
existing products and/or suspension of the sale of such products until such
Cadence intellectual property was removed.
LITIGATION PROTECTION INSURANCE. Synopsys has obtained an insurance policy
from a subsidiary of American International Group, Inc., an insurance company
rated AAA by Standard & Poors. Under the policy, the insurer will pay Synopsys,
subject to the cap described below, an amount equaling amounts paid in a
settlement or final adjudication of the Avant!/Cadence litigation, including
40
compensatory, exemplary and punitive damages, penalties, fines, attorneys' fees
and certain indemnification costs arising out of the Avant!/Cadence litigation,
which in this document we refer to as "covered loss." A covered loss does not
include:
o any losses in respect of any amendment to or refiling of the existing
Avant!/Cadence litigation complaint, to the extent such losses do not
arise from substantially the same facts as those alleged in the
existing complaint;
o any loss relating to any agreement with or obligation to individual
defendants incurred or entered into after the date of the litigation
protection insurance, unless such agreement or obligation is a
successor to an earlier agreement with no additional or enhanced
indemnification rights;
o amounts incurred before the effective time of the merger or after
settlement or final adjudication of the Avant!/Cadence litigation;
o salaries and other compensation of Synopsys, the defendants and their
officers, directors and employees; and/or
o litigation or related expenses of current, former or future directors,
officers or employees of Synopsys or the defendants, unless required
to be paid by law, by the Synopsys or Avant! charter or bylaws, by
prior agreement or by a successor to an earlier agreement with no
additional or enhanced indemnification rights.
In addition, the policy does not provide coverage for litigation other than
the Avant!/Cadence litigation.
In exchange for a premium of $335 million, including the $10 million
binding fee, the insurer will be obligated to pay covered loss up to a limit of
liability equaling (a) $500 million plus (b) interest accruing at the fixed rate
of 2%, compounded semi-annually, on $250 million less previous losses. The
policy will expire following a final judgment or settlement of the
Avant!/Cadence litigation or any earlier date upon Synopsys' election. Upon such
expiration, Synopsys will be entitled to a payment equal to $240 million plus
interest calculated as set forth above less any covered loss paid under the
policy other than the first $10 million of litigation expenses.
If there is a material breach of Synopsys' representations and warranties or
a breach of its covenant in the litigation protection insurance policy, the
insurer may cancel the insurance and must return to Synopsys $335 million plus
interest calculated as set forth above less the $10 million binding fee, less
any loss paid under the policy and less $17 million per each year, and portion
of a year, elapsed since completion of the merger. Representations and
warranties of Synopsys in the policy include, among other things, that the
factual information Synopsys and certain of its officers and representatives
provided to the insurer is accurate to the knowledge of Synopsys. Synopsys will
covenant in the policy that neither Synopsys nor Avant! nor their affiliates
will enter into any employment, consulting or other material contract or
business arrangement with Gerald C. Hsu, Mitsuru Igusa or Chih-Liang Cheng.
Under the terms of the litigation protection insurance, the insurer will
have the right to exercise full control over the defense of the Avant!/Cadence
litigation, including both the strategy and tactics to be employed, although the
insurer may not change the Avant!/Cadence litigation counsel without the consent
of Synopsys and Synopsys may effectively associate in the Avant!/Cadence
litigation defense.
Synopsys and the insurer must notify each other promptly of any settlement
discussions, and Synopsys may not make any disclosures about possible terms or
parameters of a settlement without the prior consent of the insurer and may not
have discussions regarding a settlement with Cadence or its representatives
without the prior consent of the insurer. Further, the insurer will have the
right to exclusively control the negotiation, discussion and terms of any
proposed settlement, including the right in its sole discretion to settle for an
amount in excess of $250 million (plus accrued interest less certain costs) and
less than $500 million (plus accrued interest) so long as it evaluates any
settlement as though it alone bears the entire risk of loss, except that:
o Synopsys will retain the right to settle the Avant!/Cadence
litigation, with the consent of the insurer, for up to $250 million
plus accrued interest less certain costs;
41
o Synopsys and the defendants in the Avant!/Cadence litigation will
retain the right to consent or reasonably withhold consent to any
settlement terms that are non-monetary and can be satisfied only by
future performance or forbearance to perform by Synopsys or such
defendants, as the case may be; and
o the insurer is to reasonably consider any settlement in excess of $500
million plus accrued interest.
If Synopsys withholds consent unreasonably to a settlement proposal that is
equal to or less than $250 million plus accrued interest, and losses ultimately
exceed the amount of that settlement proposal, the insurer will not be liable
for payment of losses in excess of that proposed settlement amount. If Synopsys
or the defendants withholds consent unreasonably to non-monetary terms of a
settlement, and losses ultimately exceed the amount of that settlement proposal,
the insurer will not be liable for payment of losses in excess of that proposed
settlement amount. Synopsys and the defendants in the Avant!/Cadence litigation
will be required to consent to any injunctive or similar relief that forbids or
limits the use of software code misappropriated by the defendants or the
marketing or sale of products which contain software code misappropriated by the
defendants.
The insurance policy is designed to reduce the financial risk to which
Synopsys may be exposed as a result of the Avant!/Cadence litigation. While
Synopsys believes, based on its due diligence investigation, that the aggregate
losses in the Avant!/Cadence litigation (calculated after applying any amount of
the restitution payment that is available as an offset to such losses) are
likely to be less than the insurance coverage limit of $500 million plus accrued
interest, the ultimate amount of such losses is uncertain. The insurance policy
provides Synopsys with greater certainty as to the financial cost to Synopsys in
the event of an adjudication or settlement of the Avant!/Cadence litigation not
exceeding $500 million plus accrued interest less defense costs. After
considering the likely ranges of damage amounts and potential nonmonetary
remedies that might result from the litigation, the market for insurance of this
type, alternative means of reducing Synopsys' exposure to risks arising from the
litigation, tactical and strategic issues associated with the insurer's control
of the litigation and other terms of the proposed policy, Synopsys' present and
likely future financial condition and capital needs, the costs and benefits to
Synopsys of the proposed coverage limit and the rate of interest on $250
million, legal issues associated with the insurance, and other factors that
Synopsys deemed relevant, Synopsys determined that the terms and coverage limit
of the policy were appropriate. However, there can be no assurance that losses
from the Avant!/Cadence litigation will not exceed the insurance policy's
coverage limit by a significant amount or that payment under the policy will be
obtained. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors Affecting Future Results- The Insurer Under the
Litigation Insurance May Be Prevented from Paying for Certain Losses on the
Grounds that such Payment Violates Public Policy " and "-- Synopsys Does Not
Have Control Over Defense of the Avant!/Cadence Litigation or the Authority to
Settle the Avant!/Cadence Litigation except in Limited Circumstances."
OTHER LITIGATION MATTERS. Prior to the merger, Avant! leased five buildings
in Fremont, California. Synopsys has accrued an aggregate of $54.2 million with
respect to closure of these facilities. The buildings are vacant and Avant! is
not currently paying rent on the underlying leases. The lease on one of these
buildings was the subject of litigiation commenced prior to the closing of the
merger, and it is possible that additional litigation will be commenced.
Synopsys makes no assurance that the amount accrued will be sufficient to
satisfy any current or future claims made by Renco or any other landlord with
respect to the former Avant! facilities.
Renco Investment Company is the landlord on the premises at 46859, 46871 and
46897 Bayside Parkway. Renco is the owner of the other two properties, which
were occupied by Avant! under subleases. On October 24, 2000, Avant! assigned
its lease on the premises at 46897 Bayside Parkway to Comdisco, Inc. In July
2001, Comdisco filed Chapter 11 bankruptcy, and on September 8, 2001 rejected
the lease in the bankruptcy proceeding. Although Avant! retained no possessory
interest in the property it was not released from any obligations under the
lease; therefore Avant! remains obligated to pay rent and common area
maintenance charges. On February 7, 2002 Renco filed suit in Alameda County
Superior Court claiming damages against Avant! on account of Comdisco's
rejection of the lease. The complaint asks for rent damages in the sum of
approximately $37.2 million and approximately $5.9 million build out damages.
Avant! is vigorously defending these claims. In August 2002, the court in the
Comdisco bankruptcy proceeding reserved $10.5 million in aggregate for Avant!'s
and Renco's claims (in addition to the $5.3 million security deposit), there is
no assurance that Avant! and Renco will ultimately be able to collect such
amount in such proceeding, but the reserve acts as a cap on their collective
recovery.
42
To date, Renco has not declared a default on the Avant! leases on 46859 and
46871 Bayside Parkway based on the cross-default provisions in those leases;
however, on September 13, 2002 after Avant! failed to pay rent for September,
Renco served Avant! with a notice of breach under the leases on those buildings.
On August 10, 2001, Silicon Valley Research, Inc. (SVR) filed an action
against Avant! in the United States District Court for the Northern District of
California. The complaint purports to state claims for statutory unfair
competition, receipt, sale and concealment of stolen property, interference with
prospective economic advantage, conspiracy, false advertising, violation of the
Lanham Act and violation of 18 U.S.C.A. ss. 1962 (R.I.C.O.). In the complaint,
SVR alleges that Avant!'s use of Cadence trade secrets damaged SVR by allowing
Avant! to develop and market products more quickly and cheaply than it could
have otherwise and that more closely tracked Cadence's approach and interface.
The complaint seeks an accounting, the imposition of a constructive trust, and
actual and exemplary damages. Avant! has moved to dismiss the claims for
statutory unfair competition, receipt, sale and concealment of stolen property,
negligent interference with prospective economic advantage, conspiracy, and
violation of 18 U.S.C.A. ss. 1962 (R.I.C.O.). Avant! has filed an answer in
response to the remaining claims. Co-defendant Stephen Wuu moved to dismiss all
claims. The court held a hearing on the motions to dismiss on December 14, 2001,
and it took both motions under submission. Avant! believes it has defenses to
SVR's claims and intends to defend itself vigorously. These defenses include,
but are not limited to, defenses based on the authority granted to Avant! by the
written release agreement signed between Cadence and Avant! in 1994, Avant!'s
denial of any post-release misappropriation of Cadence trade secrets, Avant!'s
belief that any use by Avant! of Cadence trade secrets did not confer any
competitive advantage on Avant! over SVR, and Avant!'s belief that SVR's loss of
market share resulted from factors other than any use by Avant! of Cadence trade
secrets. Should SVR's claims succeed, however, Avant! could be required to pay
monetary damages to SVR. Accordingly, an adverse judgment could seriously harm
Avant!'s business, financial position and results of operations.
Between July and October 2001, three derivative actions were filed against
Avant! and certain of its officers and directors: Scott v. Muraki, et al., No.
01-017548 (Cal. Superior Ct.); Louisiana School Employees' Retirement System v.
Muraki, et al., C.A. No. 19091 (Del. Chancery Ct.); and Peterson v. Hsu, et al.,
C.A. No. 19178 (Del. Chancery Ct.). The actions allege, in substance, that
certain present and former Avant! officers and directors caused damage to Avant!
by misappropriating trade secrets from competitors, making false representations
to investors and the public, and causing Avant! to award lucrative employment
contracts, bonuses, stock option grants, and valuable consulting contracts and
ownership interests in companies affiliated with Avant!. The Louisiana School
Employees' Retirement System case was dismissed in August 2002. The plaintiffs
in the remaining actions have agreed to several extensions of the defendants'
deadline for responding to their respective complaints. Accordingly, the
defendants have not moved to dismiss the actions or otherwise responded to
plaintiffs' allegations. None of the parties to the remaining actions has
initiated any discovery requests, and no depositions have been taken. The
defendants believe they have meritorious legal and factual defenses to the
actions but, because the cases are in their initial stages, and because no court
appearances have occurred, no motions have been heard, and no discovery has been
taken, the ultimate outcome of the cases is uncertain. In addition, the
individual officers and directors may have indemnification rights against the
company which may reduce or eliminate any recovery by the company from the
litigation.
Silvaco International and Silvaco Data Systems previously maintained an
action against Avant! in which they were awarded damages of over $26 million by
the trial court on claims for defamation and intentional interference with
economic advantage based on statements made between November 1995 and June 1996
to Silvaco customers and prospective customers by Meta Software, Inc., which
Avant! acquired in 1996. Avant! paid Silvaco an aggregate of $20.5 million in
settlement of this litigation in June 2002.
Sequence Design, Inc. previously maintained an action against Avant!
alleging that Star-RC and Star-RCXT, Avant!'s key parasitic extraction products,
infringe a patent owned by Sequence and seeking unspecified damages. In August
2002, the parties settled this litigation, the terms of which settlement
included limited cross-licenses of technology by each company.
On October 18, 2001, Dynasty Capital Services LLC submitted a Notice of
Submission of Dispute against Avant! to the American Arbitration Association,
43
and Randolph L. Tom subsequently submitted a Notice of Submission of Dispute
against Avant! to the American Arbitration Association. The dispute arose from
an advisory services agreement between Avant! and Dynasty Capital Services LLC
and a legal services agreement between Avant! and Mr. Tom. In February 2002,
Avant! resolved all claims between it and Dynasty Capital Services LLC and Mr.
Tom by agreeing to pay a total of $5.4 million, the last installment of which
was paid in June 2002.
The Avant!/Cadence litigation, the other pending Avant! litigation and any
future litigation against Synopsys or Avant!, regardless of the outcome, are
expected to result in substantial costs and expenses to Avant! and could
seriously harm Avant!'s business, financial condition and results of operations.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
On June 4, 2002, the Annual Meeting of Stockholders of Synopsys, Inc. was held
in Mountain View, California. Three matters were submitted to the stockholders
for action or approval.
1. The stockholders approved the issuance of the Company's common shares to be
received by Avant! Corporation stockholders in the merger of Avant! into
Maple Forest Acquisition L.L.C..
For Against Abstain Non-Votes
---------------- ----------- ----------- -------------
52,358,454 333,878 33,600 5,818,803
The stockholders elected eight directors to hold office for a one-year term or
until their respective successors are elected. The votes for these directors are
set forth below.
Total Vote Total Vote
For Each Withheld From
Director Each Director
---------------- ------------------
Aart J. de Geus 58,414,347 130,388
Andy D. Bryant 58,246,300 298,435
Chi-Foon Chan 58,405,198 139,537
Bruce R. Chizen 58,414,479 130,256
Deborah A. Coleman 58,234,475 310,260
A. Richard Newton 58,249,933 294,802
Sasson Somekh 56,262,534 2,282,201
Steven C. Walske 56,428,344 2,116,391
3. The stockholders approved a proposal to ratify the appointment of KPMG LLP
as the Company's independent auditors for the 2002 fiscal year.
For Against Abstain Non-Votes
---------------- ----------- ----------- -------------
57,560,553 939,226 44,956 N/A
44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a.) Exhibits
None.
(b.) Reports on Form 8-k
On June 6, 2002, the Registrant filed a Current Report on Form 8-K with
respect to its acquisition of Avant! Corporation.
On July 30, 2002, the Registrant filed an Amendment on Form 8-K/A to its
report filed on June 6, 2002, which included the financial information required
by Item 7 of Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SYNOPSYS, INC.
By: /S/ ROBERT B. HENSKE
---------------------
Robert B. Henske
Senior Vice President, Finance and
Operations, and Chief Financial Officer
(Principal Financial Officer)
Date: September 17, 2002
45
CERTIFICATIONS
I, Aart J. de Geus, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Synopsys, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 12, 2002
/S/ AART J. DE GEUS
-----------------------
Aart J. de Geus
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
46
I, Robert B. Henske, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Synopsys, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 16, 2002
/S/ ROBERT B. HENSKE
----------------------
Robert B. Henske
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
47