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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED JANUARY 31, 2004

OR

FOR THE TRANSITION PERIOD FROM              TO

COMMISSION FILE NUMBER: 0-19807

SYNOPSYS, INC.

(Exact name of registrant as specified in its charter)

700 EAST MIDDLEFIELD ROAD

MOUNTAIN VIEW, CA 94043

(Address of principal executive offices, including zip code)

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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

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.

154,809,823 shares of Common Stock as of March 5, 2004

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SYNOPSYS, INC.

QUARTERLY REPORT ON FORM 10-Q

JANUARY 31, 2004

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

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SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

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SYNOPSYS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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SYNOPSYS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Synopsys, Inc. (Synopsys or the Company) has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the Securities and Exchange Commission’s rules and regulations. Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with generally accepted accounting principles. In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments) necessary to fairly present its financial position, results of operations and cash flows. The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Synopsys’ Annual Report on Form 10-K for the fiscal year ended October 31, 2003.

To prepare financial statements in conformity with generally accepted accounting principles, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Synopsys’ fiscal year and first quarter end on the Saturday nearest October 31 and January 31, respectively. Fiscal 2004 and 2003 are both 52-week years. For presentation purposes, the unaudited condensed consolidated financial statements and accompanying notes use the applicable calendar month end.

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2. GOODWILL AND INTANGIBLE ASSETS, NET

Goodwill as of January 31, 2004 consisted of the following:

Intangible assets as of January 31, 2004 consisted of the following:

Total amortization expense related to intangible assets is set forth in the table below:

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The following table presents the estimated future amortization of intangible assets:

In December 2003, the Company’s Board of Directors renewed its stock repurchase program originally approved in July 2001. Under the renewed program, the Company replenished the amount available for purchases up to $500 million, not including purchases made to date under the program. This renewed stock repurchase program replaced all prior repurchase programs authorized by the Board. The Company intends to use all common shares repurchased for ongoing stock issuances such as existing employee stock option plans, existing employee stock purchase plans and acquisitions. During the three months ended January 31, 2004, the Company repurchased approximately 4.6 million shares at an average price of $35.13 per share. The Company did not repurchase any common shares during the three months ended January 31, 2003. As of January 31, 2004, $339.1 million remained available for repurchases under the program.

The following table sets forth the components of comprehensive income, net of tax:

The Company computes basic earnings per share using the weighted-average number of common shares outstanding during the period. The Company computes diluted earnings per share using the weighted-average number of common shares and dilutive stock options outstanding under the treasury stock method during the period.

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The table below reconciles the weighted-average common shares used to calculate basic net income per share with the weighted-average common shares used to calculate diluted net income per share.

The effect of dilutive stock options outstanding excludes approximately 0.8 million and 19.8 million stock options for the three months ended January 31, 2004 and 2003, respectively, which were anti-dilutive for net income per share calculations.

In accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, the Company applies the intrinsic value method in accounting for its employee stock-based awards. Accordingly, the Company generally recognizes no compensation expense with respect to stock-based awards to employees. The Company has determined unaudited pro forma information regarding net income and earnings per share as if the Company had accounted for employee stock options and employee stock purchases under the fair value method as required by Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation. The weighted-average expected life, risk-free interest rate and volatility for the three months ended January 31, 2004 and 2003 are comparable to those for the fiscal year ended October 31, 2003.

The Company’s unaudited pro forma net income and earnings per share data under SFAS 123 are as follows:

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Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, requires disclosures of certain information regarding operating segments, products and services, geographic areas of operation and major customers. SFAS 131 reporting is based upon the “management approach.” Under this method, management organizes the Company’s operating segments for which separate financial information is (i) available and (ii) evaluated regularly by the Chief Operating Decision Maker (CODM) in deciding how to allocate resources and in assessing performance. Synopsys’ CODMs are the Company’s Chief Executive Officer and Chief Operating Officer.

The Company provides software, intellectual property and consulting services to the semiconductor and electronics industries. In making operating decisions, the CODMs primarily consider consolidated financial information, accompanied by disaggregated information about revenues by geographic region and product platform. The Company operates in a single segment. Revenue is defined as revenues from external customers.

Revenue and long-lived assets related to operations in the United States and other geographic areas were:

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.

For management reporting purposes, the Company organizes its products and services into five distinct groups: Galaxy Design Platform, Discovery Verification Platform, Intellectual Property, Design for Manufacturing and Professional Services & Other. The Company includes revenue from companies or products it has acquired during the periods covered from the acquisition date through the end of the relevant periods. For presentation purposes, the Company allocates revenue derived from software maintenance, which represented approximately 16% and 23% of its total revenue, and approximately 82% and 86% of its total service revenue, for the three months ended January 31, 2004 and 2003, respectively, to the products to which those support services relate. Further, with the adoption of the Company’s platform strategy in fiscal 2003, the Company redefined its product groups and has reclassified prior period revenues in accordance with this grouping to provide a consistent presentation.

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Revenue derived from Intel Corporation and its subsidiaries in the aggregate accounted for approximately 10.6% of the Company’s total revenue for the three months ended January 31, 2004, and 10.9% of the Company’s total revenue for the three months ended January 31, 2003. Andy D. Bryant, Intel Corporation’s Executive Vice President and Chief Financial and Enterprise Services Officer, also serves on the Company’s Board of Directors. Management believes all transactions between the two parties were carried out on an arm’s length basis.

The following table presents a summary of other (expense) income components:

On February 23, 2004, the Company entered into a definitive agreement to acquire Monolithic System Technology, Inc. (MoSys), a leading provider of high-density embedded memory solutions, in a cash and stock transaction valued at approximately $453 million. The Company expects to close the acquisition by the end of May 2004. The acquisition will be effected by means of an exchange offer by a wholly-owned subsidiary of the Company to acquire all of MoSys’ outstanding shares for a purchase price of $13.50 per share, half payable in Synopsys common stock and half payable in cash. At any time prior to two business days before expiration of the offer, as it may be extended, Synopsys may elect to pay the entire purchase price in cash. The acquisition is subject to certain conditions, including the tender of a specified number of shares, receipt of regulatory approvals and other conditions set forth in the definitive agreement. Synopsys intends to assume all outstanding MoSys stock options in the transaction. The boards of directors of both companies have approved the transaction. In addition, certain MoSys stockholders who collectively own approximately 29% of MoSys’ outstanding shares have agreed to tender their shares in the transaction.

In February 2004, Synopsys completed its acquisition of Accelerant Networks, Inc., its acquisition of the assets of Analog Design Automation, Inc. and its acquisition of the test-related assets of iRoC Technologies S.A., with an aggregate purchase price of approximately $40 million. The Company does not consider any of these transactions individually material to the Company’s balance sheet or results of

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operations. The Company expects to allocate the purchase price for each of these transactions primarily to in-process research and development and/or core/developed technology.

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes to unaudited condensed consolidated financial statements in Item 1 of this report. This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the Exchange Act). Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in this discussion, especially under the caption “Factors that May Affect Future Results,” and elsewhere in this Form 10-Q. The words “may,” “will,” “could,” “would,” “anticipate,” “expect,” “intend,” “believe,” “continue,” or the negatives of such terms, or other comparable terminology and similar expressions identify these forward-looking statements. The information included herein is as of the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC) and future events or circumstances could differ significantly from these forward-looking statements. Accordingly, we caution readers not to place undue reliance on such statements.

Overview

The following summary of the discussion and analysis of our financial condition and results of operations is qualified in its entirety by the more complete discussion contained in this Item 2 and by the risk factors set forth below under the caption entitled “Factors That May Affect Future Results.”

Synopsys is the world leader in electronic design automation (EDA) software for semiconductor design. We deliver technology-leading semiconductor design and verification platforms and integrated circuit (IC) manufacturing software products to the global electronics market, enabling the development and production of complex systems-on-chips (SoCs). We also provide intellectual property (IP) and design services to simplify the design process, reduce design costs and accelerate time-to-market for our customers.

Business Environment

We generate substantially all of our revenue from the semiconductor and electronics industries. Our customers typically fund purchases of our software and services out of their research and development (R&D) budgets. As a result, our revenue is heavily influenced by our customers’ long-term business outlook and willingness to invest in new, and increasingly complex, chip designs.

Beginning in late calendar 2000, the semiconductor industry entered its steepest and longest downturn of the past 20 years, with industry sales dropping approximately 46% from late 2000 to early 2002. As a result, over the past three years our customers have focused on controlling costs and reducing risk, including constraining R&D expenditures, reducing the number of design engineers they employ, cutting back on their design starts, purchasing from fewer suppliers, requiring more favorable pricing, payment and license terms from those suppliers, and pursuing consolidation within their own industry. Further, during this downturn, many start-up semiconductor design companies failed or were acquired and the pace of investment in new companies declined.

The semiconductor industry recovered modestly in 2003 and industry analysts have forecasted semiconductor industry revenue growth in the range of 20% and R&D spending growth in the range of 5% in 2004. Historically, growth in semiconductor revenue has typically led to growth in R&D spending by semiconductor companies as they expand their design activity, although usually with a lag between the upturn in revenue and the upturn in R&D spending. While we believe this pattern should be repeated if the current recovery continues as forecasted, we cannot predict the timing or magnitude of any such increase.

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Acquisitions

On February 23, 2004, Synopsys entered into a definitive agreement to acquire Monolithic System Technology, Inc. (MoSys), a leading provider of high-density embedded memory solutions, in a cash and stock transaction valued at approximately $453 million. This acquisition, which will be effected by means of an exchange offer and is expected to close by the end of May 2004, will provide Synopsys with memory IP offering a combination of high density, low power consumption, high speed and low cost. We have the option, not less than two business days before expiration of the exchange offer, as it may be extended, to elect to pay the entire purchase price in cash.

On February 20, 2004, we acquired Accelerant Networks Inc. (Accelerant), a provider of low-power, high-speed analog interface technology, enhancing our connectivity IP offerings.

On February 23, 2004, we acquired certain test-related assets of iRoC Technologies S.A. (iRoC), which will help expand our offerings of products used to test manufactured ICs.

Finally, on February 26, 2004, we acquired substantially all of the assets of Analog Design Automation, Inc. (ADA), which provides us with automated circuit optimization solutions for analog, mixed-signal and custom integrated circuits.

The aggregate consideration for the Accelerant, iRoC and ADA acquisitions was approximately $40 million in cash, which we paid in our second fiscal quarter ending April 30, 2004.

Product Developments

During the first quarter of fiscal 2004, we introduced a number of new products and enhancements to existing products, including:

Financial Performance for the Three Months Ended January 31, 2004

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Critical Accounting Policies

We base the discussion and analysis of our financial condition and results of operations for the three months ended January 31, 2004 upon our unaudited condensed consolidated financial statements for such period, which we prepare in accordance with accounting principles generally accepted in the United States of America. In preparing these financial statements, we must make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses and related disclosure of our contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions we believe are reasonable under the circumstances. Our actual results may differ from these estimates.

The accounting policies that most frequently require us to make estimates and judgments, and therefore are critical to understanding our results of operations, are:

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Description of Policies. Other than our revenue recognition policy, which is summarized below, our critical accounting policies reflecting these estimates and judgments are described in Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended October 31, 2003, filed with the SEC on January 29, 2004. We have not changed those policies since such date. Investors should therefore read this Item 2 in conjunction with such description.

Revenue Recognition. We have designed and implemented revenue recognition policies in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, and SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition.

With respect to software sales, Synopsys utilizes three license types:

We sometimes refer to TSLs and term licenses, either individually or collectively, as “renewable licenses.”

We report revenue in three categories: upfront license revenue, time-based license revenue and services.

Upfront license revenue includes:

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Time-Based License (TBL) revenue includes:

Services revenue includes:

We allocate revenue on software transactions (referred to as an “arrangement” in the accounting literature) involving multiple elements to each element based on the relative fair values of the elements. Our determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (VSOE). We limit our assessment of VSOE for each element to the price charged when the same element is sold separately.

We have analyzed all of the elements included in our multiple-element arrangements and determined that we have sufficient VSOE to allocate revenue to the maintenance components of our perpetual and term license products and to consulting. Accordingly, assuming all other revenue recognition criteria are met, we recognize revenue from perpetual and term licenses upon delivery using the residual method in accordance with SOP 98-9 and recognize revenue from maintenance ratably over the maintenance term.

Customers occasionally request the right to convert their existing TSLs to perpetual licenses. Customers pay an incremental fee to convert the TSL to a perpetual license, which we recognize upon contract signing, in accordance with AICPA Technical Practice Aid (TPA) 5100.74, assuming all other revenue recognition criteria have been met. In some situations, the contract converting the TSL to a perpetual license is modified to such an extent that a new arrangement exists. The changes to the contract may include increases or decreases in the total technology under license, changes in payment terms, changes in license terms and other pertinent factors. In these situations, we account for all of the arrangement fees as a new sale and recognize revenue when all other revenue recognition criteria have been met. We have a policy that defines the specific circumstances under which such transactions are accounted for as a new perpetual license sale.

We make significant judgments related to revenue recognition. Specifically, in connection with each transaction involving our products, we must evaluate whether (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) our fee is fixed or determinable, and (iv) collectibility is probable. We apply these criteria as discussed below.

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Results of Operations

Revenue Background. Prior to the fourth quarter of fiscal 2000, we principally licensed our software through perpetual licenses and upfront term licenses, with the license revenue typically recognized upfront at the time we received the order and maintenance recognized ratably over the maintenance term. In the fourth quarter of fiscal 2000, we introduced TSLs. Since we bundle products and maintenance in TSLs, we generally recognize both product and service revenue ratably over the term of the license, or, if later, as payments become due. As a result, a TSL order results in significantly lower current-period revenue than an equal-sized order for a perpetual or upfront term license. Conversely, a TSL order will result in higher revenue recognized in future periods than an equal-sized order for a perpetual or upfront term license. For example, on a $120,000 order for a perpetual or upfront term license, we recognize $120,000 of revenue in the quarter the product is shipped and no revenue in future quarters. On a $120,000 order for a three-year TSL shipped on the first day of the quarter, we recognize $10,000 of revenue in the quarter the product is shipped and in each of the eleven succeeding quarters.

Because we generally recognize revenue on TSLs ratably over the TSL term, our reported revenue dropped significantly following our adoption of TSLs in the fourth quarter of fiscal 2000. Since then, however, our ratable revenue has grown as TSL orders we receive each quarter contribute revenue that is “layered” over the revenue recognized from TSL orders we received in prior quarters. As the TSL model matures, growth in ratable revenue in any quarter will depend on revenue derived from new TSL orders received in the current and previous quarters, offset by the loss of revenue from TSLs that expire in such quarter, which cease to contribute to revenue. Due to this “layering” effect, revenue may grow from quarter to quarter for some time even if orders do not grow, or may not grow from one quarter to the next at the same rate that orders grow.

Our license revenue in any given quarter depends upon the volume of upfront licenses shipped during the quarter, the amount of TBL revenue recognized from TBLs booked in prior periods, and to a much smaller degree, the amount of revenue recognized on TBL orders booked during the quarter. We set our revenue targets based in large part on orders targets and our expected mix of upfront and time-based licenses for a given period. If we achieve the total orders target but not our target license mix, we may not reach our revenue targets (if upfront license orders are lower than we expect) or may exceed them (if upfront license orders are higher than we expect). If we achieve the target license mix but orders are below target, then we will not meet our revenue targets.

The precise mix of orders can fluctuate substantially from quarter to quarter. Our historical average license order mix since adopting TSLs in August 2000 through the end of fiscal 2003 has been 24% upfront licenses and 76% time-based licenses, although the percentage of upfront license orders in any given

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quarter has varied between 14% and 33%. The license order mix for the three months ended January 31, 2004 was 57% upfront and 43% time-based. The percentage of upfront licenses was higher than our historical average due to the acceptance by our customer base of term licenses and by a lower overall level of software orders than expected.

Below is a table showing the breakdown of orders by license type for the last five fiscal quarters.

Reported Revenue. Total revenue for the three months ended January 31, 2004 increased 6% to $285.3 million compared to $268.1 million for the same period in fiscal 2003. Revenue for the three months ended January 31, 2004 consisted of 60% time-based license, 21% upfront license, and 19% service. The increase in total revenue in the three months ended January 31, 2004 compared to the same period in fiscal 2003 was primarily due to increased time-based license revenue, partially offset by a decline in service revenue, as discussed below.

Upfront license revenue for the three months ended January 31, 2004 increased 9% to $59.5 million compared to $54.5 million for the same period in fiscal 2003. The increase in upfront license revenue was primarily due to the contribution of $32.4 million in upfront term licenses, which we reintroduced in the fourth quarter of fiscal 2003. Customer acceptance of term licenses has been driven by the fact that they are shorter term, more flexible and generally less expensive than perpetual licenses. The increase in revenue from upfront term licenses was partially offset by a decline in revenue from perpetual licenses booked during the quarter. In the near term, we expect the contribution from upfront term licenses to increase and the contribution from perpetual licenses to continue to decline.

Time-based license revenue for the three months ended January 31, 2004 increased 21% to $170.6 million compared to $141.2 million for the same period in fiscal 2003. The increase in time-based license revenue was primarily due to the “layering” effect of continued bookings of TSL orders during prior quarters.

Service revenue for the three months ended January 31, 2004 decreased 24% to $55.2 million compared to $72.4 million for the same period in fiscal 2003. As discussed above, service revenue is comprised of two main components: maintenance fees and professional services fees. The overall decrease in service revenue is due mostly to the decline in maintenance fees, which declined by approximately $16.7 million for the three months ended January 31, 2004 compared to the same period in fiscal 2003 due to (i) a lower renewal rate of maintenance on perpetual licenses, (ii) our adoption of variable maintenance perpetual arrangements, in which the maintenance rate is lower than the maintenance rate on our standard perpetual licenses, and (iii) our adoption of TSLs, which bundle maintenance with the software and do not contribute any separately recognized maintenance revenue. We expect these factors will continue to negatively impact maintenance revenue during the remainder of fiscal 2004 as compared to fiscal 2003.

Professional services fees have declined in prior quarters due to adverse economic conditions which led our customers to reduce their costs by curtailing their use of outside consultants. Although professional services revenue for the three months ended January 31, 2004, at $10.0 million, is down 5% from $10.5 million for the same period in fiscal 2003, we are seeing increasing demand for professional services leading us to believe that the consulting business has stabilized, although quarterly revenue may continue to fluctuate from quarter to quarter.

Orders and Revenue Seasonality. Historically, orders and revenue have been lowest in our first quarter and highest in our fourth quarter, with a material decline between the fourth quarter of one fiscal year and the first quarter of the next fiscal year. The difference is more pronounced in orders than in revenue, because, under our license model, we typically derive between 70 and 80% of the revenue in any quarter from committed, non-cancelable backlog (i.e., from orders received in prior quarters), which means that quarter-to-quarter changes in orders do not result in equal changes in revenue. As expected, revenue for the three months ended January 31, 2004 declined 10% from revenue of $316.5 million for the fourth quarter of fiscal 2003. Orders also declined, as expected, although they were at the lower end of our expectations. Our book-to-bill ratio for the first quarter of fiscal 2004 was between 0.5 and 0.6, as compared to 1.2 to 1.3 for the fourth quarter of fiscal 2003.

In fiscal 2004 we expect the first fiscal quarter will contribute a somewhat lower than typical proportion of orders and the fourth quarter will contribute a somewhat higher than typical proportion of orders, based on our expectations regarding contract renewals we believe will be entered into later this fiscal year and continued recovery in the semiconductor industry. However, we can provide no assurances that these renewals or such continued recovery will in fact occur.

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Revenue—Product Groups. For management reporting purposes, we organize our products and services into five distinct groups: Galaxy Design Platform, Discovery Verification Platform, Intellectual Property (IP), Design for Manufacturing and Professional Services & Other.

Since our adoption of TSLs in the fourth quarter of fiscal 2000, we have derived an increasingly substantial portion of our revenue from time-based license orders placed in prior quarters. TSLs, which have an average duration of approximately three years and typically include multiple products, enhance revenue predictability while reducing quarter-to-quarter variations in revenue contributions from our product groups. Accordingly, significant changes in revenue contribution from different groups have recently been driven by one-time events, or by the mix of upfront versus time-based orders received for certain products during any given quarter.

For example, following our acquisition of Avant! Corporation in June 2002, the percentage of revenue attributable to our Galaxy Design Platform and Design for Manufacturing groups increased as the substantial majority of Avant!’s revenue was derived from products in those groups. Further, the increase in Galaxy Design Platform revenue as a percentage of total revenue for the second quarter of fiscal 2003 was due to a number of large orders from our Japanese customers, many of which were for perpetual licenses for a disproportionate amount of products from the Galaxy Design Platform, which therefore yielded significant upfront revenue contributions from that product group for that quarter.

Accordingly, while we expect fluctuations in the revenue contributions, on a percentage basis, from our five product groups will continue to be driven largely by one-time events and the level of upfront licenses for particular products entered into in any given quarter, we believe our IP and Design for Manufacturing products will, over time, account for increasing percentages of total revenue as a result of our customers’ greater acceptance of and reliance upon pre-designed, pre-verified IP components and increasing customer acceptance of tools and technologies for the manufacture of very small geometry ICs.

The following table summarizes the revenue attributable to these groups as a percentage of total revenue for the last eight quarters. We include revenue from companies or products we have acquired during the periods covered from the acquisition date through the end of the relevant periods. For presentation purposes, we allocate revenue derived from software maintenance, which represented approximately 16% and 23% of our total revenue and approximately 82% and 86% of our total service revenue for the three months ended January 31, 2004 and 2003, respectively, to the products to which those support services related. Further, with the adoption of our platform strategy in fiscal 2003, we redefined our product groups and have reclassified prior period revenues in accordance with this grouping to provide a consistent presentation.

Galaxy Design Platform. Our Galaxy Design Platform includes our logic synthesis, physical synthesis, physical design, timing analysis, signal integrity analysis and physical verification products, as well as certain analog and mixed-signal tools. Our principal products in this category are Design Compiler, Apollo^™, Astro, Physical Compiler, Prime Time, Hercules^™, Star RXCT^™ and DFT Compiler^™. We believe physical implementation, physical synthesis and design analysis products will account for an

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increasing share of Galaxy Design Platform revenue relative to our logic synthesis products as customers recognize the importance of using physical level design and analysis tools to address challenges particular to small geometry designs.

Discovery Verification Platform. Our Discovery Verification Platform includes our verification and simulation products. Our principal products in this category are VCS, HSPICE^®, NanoSim^®, Formality^®, Vera System Studio, LEDA and Magellan^™ as well as certain analog and mixed-signal tools. In addition, during the three months ended January 31, 2004 we announced our Discovery AMS Platform, a subset of our verification technologies tuned to perform verification on analog and mixed-signal designs.

Intellectual Property. We offer differentiated, high-value IP solutions, including the DesignWare^® library of IC design components and verification models and the products we acquired from inSilicon Corporation in September 2002. We have also entered into an acquisition agreement with MoSys which, upon completion of the transaction, would provide high-density embedded memory IP products. We have also made a formal decision to stop marketing the cell library technology we acquired in our acquisition of Avant! in fiscal 2002 and to focus instead on providing library services. Revenue in this area is particularly sensitive to the level of IP license orders, as IP licenses to date have been primarily upfront licenses.

Design for Manufacturing. Our Design for Manufacturing products and technologies address the design and production challenges of very small geometry ICs and include our CATS^® and Proteus OPC^™ products and our phase-shift masking technologies.

Professional Services & Other. Our Professional Services group provides consulting services, including design methodology assistance, specialized systems design services, turnkey design and training.

Events Affecting Cost of Revenues and Operating Expenses

Temporary Shutdown of Operations. During the three months ended January 31, 2004, we temporarily shut down operations in North America for three days as a cost-saving measure, resulting in savings of approximately $3.3 million as follows:

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Workforce Reduction. We reduced our workforce during the three months ended January 31, 2003. The purpose was to reduce expenses by decreasing the number of employees in all departments in domestic and foreign locations. As a result, we decreased our workforce by approximately 200 employees. The associated charge for severance and termination benefits during the three months ended January 31, 2003 was $4.4 million. The workforce reduction resulted in operating expense savings during the three months ended January 31, 2003 as follows:

Workforce Realignment. During the three months ended October 31, 2003 and effective in the three months ended January 31, 2004, we realigned our operations in order to focus resources on more strategic areas of investment and to become more operationally efficient. This realignment affected a total of approximately 240 employees (140 in the U.S. and 100 outside the U.S.) in all departments in domestic and foreign locations. Charges for severance and other termination benefits were reflected in our consolidated financial statements for the fiscal year ended October 31, 2003.

In the three months ended January 31, 2004 and as a further result of our workforce realignment, we incurred additional facilities closure costs of $1.7 million and disbursed $7.9 million in cash relating to severance and termination benefits. We expect to incur an additional $2.0 million in costs during the remainder of fiscal 2004 in connection with consolidation of excess facilities and termination of certain lease obligations as required by this realignment.

Cost of Revenue. Cost of revenue includes personnel and related costs to provide product support, consulting services and training. Cost of revenue also includes software production costs, product packaging, documentation, amortization of capitalized software development costs, amortization of purchased technology and other intangible assets as described below. Management allocates these expenses to cost of upfront licenses, cost of time-based licenses and cost of services, based on orders booked within a given quarter. Hence, the costs allocated to upfront licenses, time-based licenses and services are heavily dependent on the mix of software orders received during any given period.

The amortization of intangible assets and deferred stock compensation component of cost of revenue includes the amortization of the contract rights intangible associated with certain executory contracts and the amortization of core/developed technology related to acquisitions that were completed during fiscal 2002 and 2003. Total amortization of intangible assets and deferred stock compensation included in cost of revenue is as follows:

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Total cost of revenue for the three months ended January 31, 2004 increased 5% to $61.1 million compared to $58.5 million for the same period in fiscal 2003. The dollar increase is due primarily to an increase in amortization of core/developed technology recorded as a result of our acquisitions completed during fiscal 2003. Total cost of revenue as a percentage of total revenue for the three months ended January 31, 2004 decreased to 21% compared to 22% for the same period in fiscal 2003. The percentage decrease is primarily due to our total product costs being relatively fixed and not fluctuating significantly with changes in revenue or license mix.

Research and Development. Research and development expenses for the three months ended January 31, 2004 increased 5% to $70.3 million compared to $67.3 million for the same period in fiscal 2003. The increase consists primarily of $5.4 million in research and development personnel and related costs as a result of a 3% increase in research and development headcount. The headcount increase results from our acquisitions during fiscal 2003 and increased investment in research and development activities. This increase is partially offset by severance packages of $1.4 million associated with our workforce reduction during the three months ended January 31, 2003 as discussed above. We expect to increase research and development headcount by approximately 11% during the remainder of fiscal 2004 as a result of hiring during the year.

Sales and Marketing. Sales and marketing expenses for the three months ended January 31, 2004 decreased 1% to $70.7 million compared to $71.2 million for the same period in fiscal 2003. The decrease consists primarily of severance packages of $1.2 million associated with our workforce reduction during the three months ended January 31, 2003 discussed above which were not incurred during the three months ended January 31, 2004, partially offset by base compensation increases incurred during the three months ended January 31, 2004.

General and Administrative. General and administrative expenses for the three months ended January 31, 2004 increased 29% to $29.1 million compared to $22.6 million for the same period in fiscal 2003. The increase consists primarily of (i) $5.4 million in facilities costs due to new leases incurred and costs associated with the closing of facilities as planned under our workforce realignment in the three months ended October 31, 2003, (ii) $2.0 million in bad debt expense, and (iii) $1.2 million in additional general and administrative personnel and related costs as a result of a 2% increase in general and administrative headcount needed support increased overall headcount and acquired operations.

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Amortization of Intangible Assets and Deferred Stock Compensation. Amortization of intangible assets and deferred stock compensation includes the amortization of trademarks, trade names, customer relationships and covenants not to compete and is included in operating expenses as follows:

The increase in amortization of intangible assets is due primarily to our acquisitions completed during fiscal 2003.

Other (Expense) Income, Net. Other expense, net for the three months ended January 31, 2004 was $1.1 million and consisted primarily of (i) impairment charges related to certain assets in our venture portfolio of $1.4 million and (ii) other expenses of $1.3 million offset by interest income of $1.6 million. Other income, net for the three months ended January 31, 2003 was $9.2 million and consisted primarily of (i) realized gain on investments of $7.6 million; (ii) rental income of $2.6 million; and (iii) interest income of $1.2 million partially offset by (a) impairment charges related to certain assets in our venture portfolio of $1.0 million and (b) other expenses of $1.2 million. The change in other (expense) income, net for the three months ended January 31, 2004 compared to the same period in fiscal 2003 is due primarily to reduced investment gains and reduced rental income.

Income Tax Rate. Our effective tax rate for the three months ended January 31, 2004 was 26.3%, a reduction of 3.5% from the same period in fiscal 2003. The reduction was the result of an increase in taxable income in jurisdictions with a lower tax rate partially offset by a reduction in federal and state tax credits.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments decreased $80.6 million, or 12%, to $617.8 million as of January 31, 2004 from $698.4 million as of October 31, 2003. Our source of cash, cash equivalents and short-term investments has been funds generated from our business operations, including cash on hand from companies we have acquired.

Cash provided by operations was $11.3 million for the three months ended January 31, 2004 compared to $31.5 million for the same period in fiscal 2003. This decrease resulted from: (i) increased cash used to make foreign income tax payments during the three months ended January 31, 2004 which were not incurred during the same period last year, (ii) prepayment of certain maintenance contracts, (iii) increased amounts of international value added tax (VAT) refunds receivable compared to the same period last year, (iv) net changes in unrealized gains and losses related to our foreign currency hedging activities due to our reduced exposure to the Euro and fluctuation of exchange rates, partially offset by a decrease in accounts receivable due to strong collection efforts during the three months ended January 31, 2004, and an increase in deferred revenue due to the timing of installment contract billings for TSL licenses when compared to the same period last year.

Cash used in investing activities was $47.7 million for the three months ended January 31, 2004 compared to $21.3 million for the same period in fiscal 2003. During the three months ended January 31, 2004, cash used in investing activities was due to capital expenditures of $15.0 million, with the remainder consisting of net purchases of short-and long-term investments.

Cash used in financing activities was $74.8 million for the three months ended January 31, 2004 compared to cash provided by financing activities of $25.2 million for the same period in fiscal 2003. The decrease of $100.0 million in cash provided by financing activities is primarily due to the repurchase of approximately 4.6 million shares of our common stock from the open market for an aggregate purchase

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price of $160.9 million, offset in part by proceeds from sales of shares of our common stock pursuant to our employee stock option plans. We did not repurchase any treasury stock during the same period in fiscal 2003.

Accounts receivable, net of allowances, decreased $6.6 million, or 3%, to $194.4 million as of January 31, 2004 from $201.0 million as of October 31, 2003. Days sales outstanding, calculated based on revenue for the most recent quarter and accounts receivable as of the balance sheet date, increased to 62 days as of January 31, 2004 from 58 days as of October 31, 2003. The increase in days sales outstanding is due in part to a decrease in total revenue for the three months ended January 31, 2004 compared to the three months ended October 31, 2003.

We hold our cash, cash equivalents and short-term investments in the U.S. and in foreign accounts, primarily Ireland, Bermuda and Japan. As of January 31, 2004, we held an aggregate of $317.2 million in cash, cash equivalents and short-term investments in the U.S. and an aggregate of $300.6 million in foreign accounts. Funds in foreign accounts are generated from revenue outside North America. With the exception of Japan, we currently maintain a policy under APB 23, Accounting for Income Taxes-Special Areas, of permanently reinvesting such funds outside of the U.S.

As mentioned above, we have entered into a definitive agreement to acquire MoSys pursuant to an exchange offer followed by a merger in a half cash and half stock transaction valued at approximately $453 million. At any time prior to two business days before expiration of the offer, as it may be extended, we may elect to pay the entire purchase price in cash. If Synopsys exercises such option, we may be required to raise additional funds in the U.S. While we believe such financing would be readily available, we cannot currently predict with certainty the terms of such financing, including the nature of the funding, interest rates, maturity date and any covenants required by the lender or security holder. Any such financing would increase our interest expense for the period that such obligation is outstanding and/or subject us to covenants that could prohibit certain business activities.

Subsequent to the first quarter, we expended approximately $40 million in the aggregate for the Accelerant acquisition, the acquisition of certain assets of iRoC and the acquisition of the assets of ADA as discussed above.

Subject to cash requirements for pending or future acquisitions, we believe that our current cash, cash equivalents, short-term investments and cash generated from operations will satisfy our business requirements for at least the next twelve months.

Factors That May Affect Future Results

Weakness, budgetary caution or consolidation in the semiconductor and electronics industries would negatively impact our business.

Following steep declines in orders and revenue from late 2000 through 2002, the semiconductor industry modestly recovered in 2003, and industry analysts have recently forecasted industry revenue growth in the range of 20% for 2004. Historically, growth in semiconductor revenue has typically led to growth in R&D spending, and thus EDA expenditures, by semiconductor companies as they expand their design activities. However, given the depth and duration of the 2000-2002 downturn, semiconductor companies have remained cautious in their outlook on demand for their products, and have thus continued to constrain their investments in R&D, including EDA software and services. Accordingly, the current recovery remains subject to significant risks, and we therefore can provide no assurances this recovery will continue. Further, if the recovery continues, we cannot predict whether, when or to what extent that recovery will translate into increased EDA investments. If the recovery should slow, or if our customers and prospective customers continue to remain cautious in their EDA purchases due to market conditions or other factors, our business, operating results and financial condition would be materially and adversely affected.

The decline in starts of new IC designs, industry consolidation and other potentially long-term trends may have an adverse effect on the EDA industry, including demand for our products and services.

Technology innovations, such as SoC and IC designs with features of 130 nanometers and below, have substantially increased the complexity, cost and risk of designing and manufacturing ICs. While these

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trends create a market opportunity for us, they also contribute, along with the downturn in the semiconductor industry from 2000 to 2002, to the following potentially long-term negative trends:

These trends, if sustained, could have a material adverse effect on the EDA industry, including the demand for our products and services.

The EDA industry is highly competitive, and competition may have a material adverse effect on our business and operating results.

We compete with other EDA vendors that offer a broad range of products and services, such as Cadence Design Systems and Mentor Graphics Corporation, and with EDA vendors that offer products focused on one or more discrete phases of the IC design process. We also compete with customers’ internally developed design tools and capabilities. If we fail to compete effectively, our business will be materially and adversely affected.

We compete principally on technology leadership, product quality and features, post-sale support, interoperability with our own and other vendors’ products, price and payment terms. Additional competitive challenges include:

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rate, our business, operating results and financial condition would be materially and adversely affected.

Our revenue and earnings fluctuate, which could cause our financial results to not meet expectations and our stock price to decline.

Many factors affect our revenue and earnings, including customer demand, license terms, and the timing of revenue recognition on products and services sold, making it difficult to predict revenue and earnings for any given fiscal period. Accordingly, stockholders should not view our historical results as necessarily indicative of our future performance. If our financial results or targets do not meet investor and analyst expectations, our stock price could decline.

The following are some of the specific factors that could affect our revenue and earnings in a particular quarter or over several fiscal periods: