2014.07.31 Q2
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________
FORM 10-Q
___________________________________________
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended July 31, 2014
Or
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 1-34795
___________________________________________
MENTOR GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)
___________________________________________
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Oregon | 93-0786033 |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
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8005 SW Boeckman Road, Wilsonville, Oregon | 97070-7777 |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (503) 685-7000
None
(Former name, former address and former
fiscal year, if changed since last report)
___________________________________________
Indicate by check mark whether the registrant (1) 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o |
| | | | (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of shares of common stock, no par value, outstanding as of September 2, 2014: 113,676,219
MENTOR GRAPHICS CORPORATION
Index to Form 10-Q
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PART I. FINANCIAL INFORMATION | |
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Item 1. | Financial Statements (unaudited) | |
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Item 2. | | |
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Item 3. | | |
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Item 4. | | |
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PART II. OTHER INFORMATION | |
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Item 1. | | |
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Item 1A. | | |
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Item 2. | | |
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Item 6. | | |
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PART I. FINANCIAL INFORMATION
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Item 1. | Financial Statements |
Mentor Graphics Corporation
Condensed Consolidated Statements of Income
(Unaudited)
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| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
In thousands, except per share data | | | | | | | |
Revenues: | | | | | | | |
System and software | $ | 149,480 |
| | $ | 150,203 |
| | $ | 297,709 |
| | $ | 273,487 |
|
Service and support | 110,753 |
| | 103,013 |
| | 214,675 |
| | 206,244 |
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Total revenues | 260,233 |
| | 253,216 |
| | 512,384 |
| | 479,731 |
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Cost of revenues: | | | | | | | |
System and software | 16,185 |
| | 15,236 |
| | 43,156 |
| | 24,135 |
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Service and support | 30,903 |
| | 28,909 |
| | 60,014 |
| | 58,984 |
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Amortization of purchased technology | 1,841 |
| | 712 |
| | 3,202 |
| | 1,919 |
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Total cost of revenues | 48,929 |
| | 44,857 |
| | 106,372 |
| | 85,038 |
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Gross profit | 211,304 |
| | 208,359 |
| | 406,012 |
| | 394,693 |
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Operating expenses: | | | | | | | |
Research and development | 87,542 |
| | 80,307 |
| | 171,993 |
| | 160,024 |
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Marketing and selling | 82,305 |
| | 79,811 |
| | 166,939 |
| | 158,918 |
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General and administration | 19,473 |
| | 17,198 |
| | 37,155 |
| | 33,535 |
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Equity in earnings of Frontline | (2,062 | ) | | (950 | ) | | (3,441 | ) | | (1,347 | ) |
Amortization of intangible assets | 2,026 |
| | 1,556 |
| | 3,776 |
| | 3,210 |
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Special charges | 5,108 |
| | 3,859 |
| | 11,034 |
| | 7,882 |
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Total operating expenses | 194,392 |
| | 181,781 |
| | 387,456 |
| | 362,222 |
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Operating income | 16,912 |
| | 26,578 |
| | 18,556 |
| | 32,471 |
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Other income (expense), net | (104 | ) | | (272 | ) | | (362 | ) | | (1,231 | ) |
Interest expense | (4,807 | ) | | (4,897 | ) | | (9,392 | ) | | (9,682 | ) |
Income before income tax | 12,001 |
| | 21,409 |
| | 8,802 |
| | 21,558 |
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Income tax benefit | (1,768 | ) | | (2,338 | ) | | (1,942 | ) | | (1,770 | ) |
Net income | 13,769 |
| | 23,747 |
| | 10,744 |
| | 23,328 |
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Less: Loss attributable to noncontrolling interest | (403 | ) | | (235 | ) | | (877 | ) | | (859 | ) |
Net income attributable to Mentor Graphics shareholders | $ | 14,172 |
| | $ | 23,982 |
| | $ | 11,621 |
| | $ | 24,187 |
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Net income per share: | | | | | | | |
Basic | $ | 0.13 |
| | $ | 0.19 |
| | $ | 0.12 |
| | $ | 0.20 |
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Diluted | $ | 0.13 |
| | $ | 0.19 |
| | $ | 0.11 |
| | $ | 0.19 |
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Weighted average number of shares outstanding: | | | | | | | |
Basic | 113,868 |
| | 112,988 |
| | 114,396 |
| | 112,851 |
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Diluted | 116,551 |
| | 116,295 |
| | 116,960 |
| | 116,014 |
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Cash dividends declared per common share | $ | 0.050 |
| | $ | 0.045 |
| | $ | 0.100 |
| | $ | 0.090 |
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See accompanying notes to unaudited condensed consolidated financial statements.
Mentor Graphics Corporation
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
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| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
In thousands | | | | | | | |
Net Income | $ | 13,769 |
| | $ | 23,747 |
| | $ | 10,744 |
| | $ | 23,328 |
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Other comprehensive income (loss), net of tax: | | | | | | | |
Cash flow hedges: | | | | | | | |
Change in unrealized loss on derivative instruments | (232 | ) | | (15 | ) | | (149 | ) | | (270 | ) |
Less: reclassification adjustment for net loss included in net income | (238 | ) | | (23 | ) | | (83 | ) | | (267 | ) |
Net change | 6 |
| | 8 |
| | (66 | ) | | (3 | ) |
Change in accumulated translation adjustment | (3,665 | ) | | (2,119 | ) | | (703 | ) | | (7,436 | ) |
Change in pension liability | (2 | ) | | (2 | ) | | (4 | ) | | (4 | ) |
Other comprehensive loss | (3,661 | ) | | (2,113 | ) | | (773 | ) | | (7,443 | ) |
Comprehensive income | 10,108 |
| | 21,634 |
| | 9,971 |
| | 15,885 |
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Less amounts attributable to the noncontrolling interest: | | | | | | | |
Net loss | (403 | ) | | (235 | ) | | (877 | ) | | (859 | ) |
Change in accumulated translation adjustment | 15 |
| | 5 |
| | 5 |
| | 48 |
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Comprehensive loss attributable to the noncontrolling interest | (388 | ) | | (230 | ) | | (872 | ) | | (811 | ) |
Comprehensive income attributable to Mentor Graphics shareholders | $ | 10,496 |
| | $ | 21,864 |
| | $ | 10,843 |
| | $ | 16,696 |
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See accompanying notes to unaudited condensed consolidated financial statements.
Mentor Graphics Corporation
Condensed Consolidated Balance Sheets
(Unaudited) |
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As of | July 31, 2014 | | January 31, 2014 |
In thousands | | | |
Assets | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 174,361 |
| | $ | 293,322 |
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Short-term investments | — |
| | 3,990 |
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Trade accounts receivable, net of allowance for doubtful accounts of $3,294 as of July 31, 2014 and $5,469 as of January 31, 2014 | 423,699 |
| | 454,483 |
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Other receivables | 16,085 |
| | 15,506 |
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Inventory | 24,174 |
| | 25,121 |
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Prepaid expenses and other | 25,311 |
| | 24,031 |
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Deferred income taxes | 10,107 |
| | 13,656 |
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Total current assets | 673,737 |
| | 830,109 |
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Property, plant, and equipment, net of accumulated depreciation of $333,014 as of July 31, 2014 and $320,827 as of January 31, 2014 | 158,474 |
| | 160,165 |
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Term receivables | 236,743 |
| | 270,365 |
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Goodwill | 597,912 |
| | 549,044 |
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Intangible assets, net of accumulated amortization of $202,602 as of July 31, 2014 and $195,752 as of January 31, 2014 | 52,967 |
| | 22,799 |
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Other assets | 73,397 |
| | 71,627 |
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Total assets | $ | 1,793,230 |
| | $ | 1,904,109 |
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Liabilities and Stockholders’ Equity | | | |
Current liabilities: | | | |
Short-term borrowings | $ | 3,640 |
| | $ | 9,590 |
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Accounts payable | 11,360 |
| | 21,548 |
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Income taxes payable | 372 |
| | 3,365 |
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Accrued payroll and related liabilities | 51,548 |
| | 102,848 |
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Accrued and other liabilities | 40,455 |
| | 42,457 |
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Deferred revenue | 223,610 |
| | 231,179 |
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Total current liabilities | 330,985 |
| | 410,987 |
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Notes payable | 227,276 |
| | 224,261 |
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Deferred revenue | 22,266 |
| | 17,398 |
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Income tax liability | 17,565 |
| | 18,431 |
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Other long-term liabilities | 32,001 |
| | 32,259 |
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Total liabilities | 630,093 |
| | 703,336 |
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Commitments and contingencies (Note 8) |
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Noncontrolling interest with redemption feature | 13,296 |
| | 15,479 |
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Stockholders’ equity: | | | |
Common stock, no par value, 300,000 shares authorized as of July 31, 2014 and January 31, 2014; 113,633 shares issued and outstanding as of July 31, 2014 and 115,722 shares issued and outstanding as of January 31, 2014 | 802,352 |
| | 838,939 |
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Retained earnings | 329,264 |
| | 327,552 |
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Accumulated other comprehensive income | 18,025 |
| | 18,803 |
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Noncontrolling interest | 200 |
| | — |
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Total stockholders’ equity | 1,149,841 |
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| 1,185,294 |
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Total liabilities and stockholders’ equity | $ | 1,793,230 |
| | $ | 1,904,109 |
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See accompanying notes to unaudited condensed consolidated financial statements.
Mentor Graphics Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)
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| | | | | | | |
| Six months ended July 31, |
| 2014 | | 2013 |
In thousands | | | |
Operating Cash Flows: | | | |
Net income | $ | 10,744 |
| | $ | 23,328 |
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Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation of property, plant, and equipment | 17,076 |
| | 17,218 |
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Amortization of intangible assets, debt costs and other | 11,173 |
| | 8,910 |
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Stock-based compensation | 17,289 |
| | 13,843 |
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Deferred income taxes | 1,109 |
| | 4,590 |
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Changes in other long-term liabilities | (191 | ) | | (2,377 | ) |
Dividends received from unconsolidated entities, net of equity in income (loss) | (474 | ) | | 1,360 |
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Other | 87 |
| | (12 | ) |
Changes in operating assets and liabilities, net of effect of acquired businesses: | | | |
Trade accounts receivable, net | 46,837 |
| | 44,408 |
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Prepaid expenses and other | (3,045 | ) | | (11,833 | ) |
Term receivables, long-term | 36,705 |
| | 33,037 |
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Accounts payable and accrued liabilities | (77,068 | ) | | (58,645 | ) |
Income taxes payable | (5,818 | ) | | (8,701 | ) |
Deferred revenue | (15,862 | ) | | (29,967 | ) |
Net cash provided by operating activities | 38,562 |
| | 35,159 |
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Investing Cash Flows: | | | |
Proceeds from the sales and maturities of short-term investments | 4,124 |
| | 3,112 |
|
Purchases of short-term investments | — |
| | (7,820 | ) |
Purchases of property, plant, and equipment | (13,315 | ) | | (13,821 | ) |
Acquisitions of businesses and other intangible assets, net of cash acquired | (75,900 | ) | | (2,928 | ) |
Net cash used in investing activities | (85,091 | ) | | (21,457 | ) |
Financing Cash Flows: | | | |
Proceeds from issuance of common stock | 16,177 |
| | 28,619 |
|
Repurchase of common stock | (70,053 | ) | | (39,995 | ) |
Dividends paid | (11,471 | ) | | (10,143 | ) |
Net decrease in short-term borrowing | (5,949 | ) | | (1,722 | ) |
Repayments of other borrowings | (1,691 | ) | | (2,712 | ) |
Proceeds from the sale of subsidiary shares to non-controlling interest | 251 |
| | — |
|
Net cash used in financing activities | (72,736 | ) | | (25,953 | ) |
Effect of exchange rate changes on cash and cash equivalents | 304 |
| | (1,968 | ) |
Net change in cash and cash equivalents | (118,961 | ) | | (14,219 | ) |
Cash and cash equivalents at the beginning of the period | 293,322 |
| | 223,783 |
|
Cash and cash equivalents at the end of the period | $ | 174,361 |
| | $ | 209,564 |
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See accompanying notes to unaudited condensed consolidated financial statements.
Mentor Graphics Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
All numerical dollar and share references are in thousands, except for per share and conversion rate data.
(1) General
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States (U.S.) generally accepted accounting principles (GAAP) and reflect all material normal recurring adjustments. However, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the condensed consolidated financial statements include adjustments necessary for a fair presentation of the results of the interim periods presented. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2014.
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. Any changes in estimates will be reflected in the financial statements in future periods.
The condensed consolidated financial statements include our financial statements and those of our wholly-owned and majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
(2) Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is based on the principle that the amount of revenue recognized should reflect the consideration an entity expects to be entitled to in exchange for the transfer of goods and services to customers. This ASU requires disclosures enabling users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU also requires qualitative and quantitative disclosure about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. We will be required to implement this guidance in the first quarter of fiscal year 2018. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method, nor have we determined the effect of the standard on our ongoing financial reporting.
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU states that only disposals of components of an entity representing a strategic shift in operations that have or will have a major impact on operations and financial results will be presented as discontinued operations. This update requires the assets and liabilities of a discontinued operation to be presented separately in the statement of financial position for the current year and all prior periods presented. ASU 2014-08 is to be applied prospectively. We will be required to implement this guidance in the first quarter of fiscal year 2016. This update is not expected to have a material impact on our consolidated financial statements.
(3) Fair Value Measurement
The following table presents information about financial assets and liabilities measured at fair value on a recurring basis as of July 31, 2014:
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| Fair Value | | Level 1 | | Level 2 | | Level 3 |
Contingent consideration | $ | (4,561 | ) | | $ | — |
| | $ | — |
| | $ | (4,561 | ) |
The following table presents information about financial assets and liabilities measured at fair value on a recurring basis as of January 31, 2014:
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| Fair Value | | Level 1 | | Level 2 | | Level 3 |
Bank certificates of deposit | $ | 3,990 |
| | $ | — |
| | $ | 3,990 |
| | $ | — |
|
Contingent consideration | (4,571 | ) | | — |
| | — |
| | (4,571 | ) |
Total | $ | (581 | ) | | $ | — |
| | $ | 3,990 |
| | $ | (4,571 | ) |
The FASB's authoritative guidance for the hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our market assumptions. The fair value hierarchy consists of the following three levels:
•Level 1—Quoted prices for identical instruments in active markets;
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• | Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose significant inputs are observable; and |
•Level 3—One or more significant inputs to the valuation model are unobservable.
We based the fair value of bank certificates of deposit included in short-term investments on quoted market prices for similar instruments in markets that are not active (Level 2).
In connection with certain acquisitions, payment of a portion of the purchase price is contingent typically upon the acquired business’ achievement of certain revenue goals. As of July 31, 2014, of the total recorded balance, $1,663 was included in accrued and other liabilities and $2,898 was included in other long-term liabilities on our condensed consolidated balance sheet. As of January 31, 2014, of the total recorded balance, $1,565 was included in accrued and other liabilities and $3,006 was included in other long-term liabilities on our condensed consolidated balance sheet.
We have estimated the fair value of our contingent consideration as the present value of the expected payments over the term of the arrangements. The fair value measurement of our contingent consideration as of July 31, 2014 encompasses the following significant unobservable inputs:
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Unobservable Inputs | | Range |
Total estimated contingent consideration | | $0 | - | $5,187 |
Discount rate | | 9.5% | - | 16.0% |
Timing of cash flows (in years) | | 0 | - | 4 |
Changes in the fair value of our contingent consideration are primarily driven by changes in the estimated amount and timing of payments, resulting from changes in the forecasted revenues of the acquired businesses. Significant changes in any of the inputs in isolation could result in a fluctuation in the fair value measurement of contingent consideration. Changes in fair value are recognized in special charges in our condensed consolidated statement of income in the period in which the change is identified.
The following table summarizes contingent consideration activity:
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| | | |
Balance as of January 31, 2014 | $ | 4,571 |
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New contingent consideration | 1,450 |
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Payments | (1,514 | ) |
Interest accretion | 54 |
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Balance as of July 31, 2014 | $ | 4,561 |
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The following table summarizes the fair value and carrying value of notes payable:
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| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Fair value of notes payable | $ | 294,856 |
| | $ | 306,535 |
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Carrying value of notes payable | $ | 227,276 |
| | $ | 224,261 |
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We based the fair value of notes payable on the quoted market price at the balance sheet date. The quoted market price for our notes payable is derived from observable inputs including our stock price, stock volatility, and interest rate (Level 2). Of the
total carrying value of notes payable, none was classified as current on our condensed consolidated balance sheet as of July 31, 2014 and January 31, 2014.
The carrying amounts of cash equivalents, trade accounts receivable, net, term receivables, short-term borrowings, accounts payable, and accrued liabilities approximate fair value because of the short-term nature of these instruments or because amounts have been appropriately discounted.
(4) Business Combinations
For each business we acquire, the excess of the fair value of the consideration transferred over the fair value of the net tangible assets acquired and net tangible liabilities assumed is allocated to various identifiable intangible assets and goodwill. Identifiable intangible assets typically consist of purchased technology and customer-related intangibles, which are amortized to expense over their useful lives. Goodwill, representing the excess of the purchase consideration over the fair value of net tangible and identifiable intangible assets, is not amortized.
Acquisitions during the six months ended July 31, 2014
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| | | | | | | | | | | | | | | |
| Total Consideration | | Net Tangible Assets Acquired | | Identifiable Intangible Assets Acquired | | Goodwill |
Berkeley Design Automation, Inc. | $ | 51,303 |
| | $ | 2,335 |
| | $ | 24,770 |
| | $ | 24,198 |
|
Other | 39,094 |
| | 1,606 |
| | 12,540 |
| | 24,948 |
|
Total | $ | 90,397 |
| | $ | 3,941 |
| | $ | 37,310 |
| | $ | 49,146 |
|
On March 20, 2014, we acquired for cash all of the outstanding common shares of Berkeley Design Automation, Inc. (BDA), a leader in nanometer analog, mixed signal, and radio frequency circuit verification. The acquisition of BDA aligns with Mentor's goal to deliver technologies with superior performance and automation for the growing challenges of Analog/Mixed-Signal verification. The total cash consideration consisted of $46,832 paid during the six months ended July 31, 2014 and a deferred payment valued at $4,471.
The identified intangible assets acquired consisted of purchased technology with a fair value of $11,200 and other intangibles with a fair value of $13,570. The fair values of the identified intangible assets were valued using an income approach with significant unobservable inputs (Level 3). The significant unobservable inputs include annual revenue derived from each identified intangible asset and a selected discount rate of 15%. We are amortizing purchased technology to cost of revenues over five years and other intangibles to operating expenses over two to five years. The goodwill created by the transaction is not deductible for tax purposes. Key factors that make up the goodwill created by the transaction include expected synergies from the combination of operations and products and the knowledge and experience of the acquired workforce.
Other acquisitions for the six months ended July 31, 2014 consisted of two privately-held companies which were accounted for as business combinations. These acquisitions were not material individually or in the aggregate.
The separate results of operations for the acquisitions during the six months ended July 31, 2014 were not material, individually or in the aggregate, compared to our overall results of operations and accordingly pro forma financial statements of the combined entities have been omitted.
(5) Term Receivables and Trade Accounts Receivable
We have long-term installment receivables that are attributable to multi-year, multi-element term license sales agreements. We include balances under term agreements that are due within one year in trade accounts receivable, net and balances that are due more than one year from the balance sheet date in term receivables, long-term. We discount the total product portion of the agreements to reflect the interest component of the transaction. We amortize the interest component of the transaction, using the effective interest method, to system and software revenues over the period in which payments are made and balances are outstanding. We determine the discount rate at the outset of the arrangement based upon the current credit rating of the customer. We reset the discount rate periodically considering changes in prevailing interest rates but do not adjust previously discounted balances.
Term receivable and trade accounts receivable balances were as follows:
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| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Trade accounts receivable | $ | 112,530 |
| | $ | 179,830 |
|
Term receivables, short-term | $ | 311,169 |
| | $ | 274,653 |
|
Term receivables, long-term | $ | 236,743 |
| | $ | 270,365 |
|
Trade accounts receivable include billed amounts whereas term receivables, short-term are comprised of unbilled amounts. Term receivables, short-term represent the portion of long-term installment agreements that are due within one year. Billings for term agreements typically occur thirty days prior to the contractual due date, in accordance with individual contract installment terms. Term receivables, long-term represent unbilled amounts which are scheduled to be collected beyond one year.
We perform a credit risk assessment of all customers using the Standard & Poor’s (S&P) credit rating as our primary credit-quality indicator. The S&P credit ratings are based on the most recent S&P score available. For customers that do not have an S&P credit rating, we base our credit risk assessment on an internal credit assessment which is based on selected short-term financial ratios. Our internal credit assessment is based upon results provided in the customers’ most recent financial statements. We determine whether or not to extend credit to these customers based on the results of our internal credit assessment, thus, mitigating our risk of loss.
The credit risk assessment for our long-term receivables was as follows:
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| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
S&P credit rating: | | | |
AAA+ through BBB- | $ | 137,088 |
| | $ | 180,113 |
|
BB+ and lower | 28,091 |
| | 29,654 |
|
| 165,179 |
| | 209,767 |
|
Internal credit assessment | 71,564 |
| | 60,598 |
|
Total long-term term receivables | $ | 236,743 |
| | $ | 270,365 |
|
We maintain allowances for doubtful accounts on trade accounts receivable and term receivables, long-term for estimated losses resulting from the inability of our customers to make required payments. We regularly evaluate the collectibility of our trade accounts receivable based on a combination of factors. When we become aware of a specific customer’s inability to meet its financial obligations, such as in the case of bankruptcy or deterioration in the customer’s operating results, financial position, or credit rating, we record a specific reserve for bad debt to reduce the related receivable to the amount believed to be collectible. We also record unspecified reserves for bad debt for all other customers based on a variety of factors including length of time the receivables are past due, the financial health of the customers, the current business environment, and historical experience. Current economic conditions we have considered include forecasted spending in the semiconductor industry, consumer spending for electronics, integrated circuit research and development spending, and volatility in gross domestic product. If these factors change or circumstances related to specific customers change, we adjust the estimates of the recoverability of receivables resulting in either additional selling expense or a reduction in selling expense in the period the determination is made.
We reduced our allowance for doubtful accounts during the six months ended July 31, 2014 by $1,691, to reflect a change in estimate of our unspecified reserves resulting from sustained low write-off experience and strong collections. The adjustment was recorded in marketing and selling expense in our results of operations.
The following shows the change in allowance for doubtful accounts:
|
| | | | | | | | | | | | | | | | |
Allowance for doubtful accounts | | Beginning balance | | Expense adjustment | | Other deductions(1) | | Ending balance |
Six months ended July 31, 2014 | | $ | 5,469 |
| | $ | (1,951 | ) | | $ | (224 | ) | | $ | 3,294 |
|
Six months ended July 31, 2013 | | $ | 5,331 |
| | $ | (331 | ) | | $ | (186 | ) | | $ | 4,814 |
|
(1)Specific account write-offs and foreign exchange.
We enter into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. We received net proceeds from the sale of receivables of $11,405 for the six months ended July 31, 2014
compared to $9,578 for the six months ended July 31, 2013. Amounts collected from customers on accounts receivable previously sold on a non-recourse basis to financial institutions are included in short-term borrowings on the balance sheet. These amounts are remitted to the financial institutions in the month following quarter-end.
(6) Short-Term Borrowings
We have a syndicated, senior, unsecured, revolving credit facility, which expires on May 24, 2017.
The revolving credit facility has a maximum borrowing capacity of $125,000. As stated in the revolving credit facility, we have the option to pay interest based on:
| |
(i) | London Interbank Offered Rate (LIBOR) with varying maturities commensurate with the borrowing period we select, plus a spread of between 2.00% and 2.50% based on a pricing grid tied to a financial covenant, or |
| |
(ii) | A base rate plus a spread of between 1.00% and 1.50%, based on a pricing grid tied to a financial covenant. |
As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.30% and 0.40% based on a pricing grid tied to a financial covenant. We had no borrowings against the revolving credit facility during the six months ended July 31, 2014 and 2013.
This revolving credit facility contains certain financial and other covenants, including a limit on the aggregate amount we can pay for dividends and repurchases of our stock over the term of the facility of $50,000 plus 70% of our cumulative net income for the periods after January 31, 2011.
We were in compliance with all financial covenants as of July 31, 2014. If we fail to comply with the financial covenants and do not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility.
(7) Notes Payable
We have no long-term obligations maturing within the next five years. Our 4.00% Convertible Subordinated Debentures are due in 2031, but we may be required to repay them earlier under the conversion and redemption provisions described below.
4.00% Debentures due 2031
In April 2011, we issued $253,000 of 4.00% Convertible Subordinated Debentures (4.00% Debentures) due 2031 in a private placement pursuant to the SEC Rule 144A under the Securities Act of 1933. Interest on the 4.00% Debentures is payable semi-annually in April and October.
As of July 31, 2014, each one thousand dollars in principal amount of the 4.00% Debentures is convertible, under certain circumstances, into 49.365 shares of our common stock (equivalent to a conversion price of $20.26 per share) for a total of 12,489 shares. The circumstances for conversion include:
| |
• | The market price of our common stock exceeding 120.0% of the conversion price, or $24.31 per share as of July 31, 2014, for at least 20 of the last 30 trading days in the previous fiscal quarter; |
| |
• | A call for redemption of the 4.00% Debentures; |
| |
• | Specified distributions to holders of our common stock; |
| |
• | If a fundamental change, such as a change of control, occurs; |
| |
• | During the two months prior to, but not on, the maturity date; or |
| |
• | The market price of the 4.00% Debentures declining to less than 98% of the value of the common stock into which the 4.00% Debentures are convertible. |
Upon conversion of any 4.00% Debentures, a holder will receive:
| |
(i) | Cash for the lesser of the principal amount of the 4.00% Debentures that are converted or the value of the converted shares; and |
| |
(ii) | Cash or shares of common stock, at our election, for the excess, if any, of the value of the converted shares over the principal amount. |
If a holder elects to convert their 4.00% Debentures in connection with a fundamental change in the company that occurs prior to April 5, 2016, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances.
As a result of declaring cash dividends during the fiscal year ended January 31, 2014 and the six months ended July 31, 2014, the initial conversion rate for the 4.00% Debentures of 48.6902 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.54 per share of our common stock) has been adjusted to 49.365 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.26 per share of our common stock).
We may redeem some or all of the 4.00% Debentures for cash on or after April 5, 2016 at the following redemption prices expressed as a percentage of principal, plus any accrued and unpaid interest:
|
| | |
Period | Redemption Price |
|
Beginning on April 5, 2016 and ending on March 31, 2017 | 101.143 | % |
Beginning on April 1, 2017 and ending on March 31, 2018 | 100.571 | % |
On April 1, 2018 and thereafter | 100.000 | % |
The holders, at their option, may redeem the 4.00% Debentures in whole or in part for cash on April 1, 2018, April 1, 2021, and April 1, 2026, and in the event of a fundamental change in the company. In each case, our repurchase price will be 100% of the principal amount of the 4.00% Debentures plus any accrued and unpaid interest.
The 4.00% Debentures contain a conversion feature that the debt may be settled in cash upon conversion, therefore we separately account for the implied liability and equity components of the 4.00% Debentures. The principal amount, unamortized debt discount, net carrying amount of the liability component, and carrying amount of the equity component of the 4.00% Debentures are as follows:
|
| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Principal amount | $ | 253,000 |
| | $ | 253,000 |
|
Unamortized debt discount | (25,724 | ) | | (28,739 | ) |
Net carrying amount of the liability component | $ | 227,276 |
| | $ | 224,261 |
|
Equity component | $ | 43,930 |
| | $ | 43,930 |
|
The unamortized debt discount amortizes to interest expense using the effective interest method through March 2018.
We recognized the following amounts in interest expense in the condensed consolidated statement of income related to the 4.00% Debentures:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Interest expense at the contractual interest rate | $ | 2,530 |
| | $ | 2,530 |
| | $ | 5,060 |
| | $ | 5,060 |
|
Amortization of debt discount | $ | 1,521 |
| | $ | 1,416 |
| | $ | 3,015 |
| | $ | 2,807 |
|
The effective interest rate on the 4.00% Debentures was 7.25% for the six months ended July 31, 2014 and 2013.
(8) Commitments and Contingencies
Indemnifications
Our license and services agreements generally include a limited indemnification provision for claims from third parties relating to our intellectual property (IP). The indemnification is generally limited to the amount paid by the customer, a multiple of the amount paid by the customer, or a set cap. As of July 31, 2014, we were not aware of any material liabilities arising from these indemnification obligations.
Legal Proceedings
From time to time, we are involved in various disputes and litigation matters that arise in the ordinary course of business. These include disputes and lawsuits relating to IP rights, contracts, distributorships, and employee relations matters. Periodically, we review the status of various disputes and litigation matters and assess our potential exposure. When we consider the potential loss from any dispute or legal matter probable and the amount or the range of loss can be estimated, we will accrue a liability for the estimated loss. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, we base accruals on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation matters and may revise estimates. We believe that the outcome of current litigation, individually and in the aggregate, will not have a material effect on our results of operations.
In some instances, we are unable to reasonably estimate any potential loss or range of loss. The nature and progression of litigation can make it difficult to predict the impact a particular lawsuit will have. There are many reasons that we cannot make these assessments, including, among others, one or more of the following: the early stages of a proceeding; damages sought that are unspecific, unsupportable, unexplained or uncertain; discovery not having been started or incomplete; the complexity of the facts that are in dispute; the difficulty of assessing novel claims; the parties not having engaged in any meaningful settlement discussions; the possibility that other parties may share in any ultimate liability; and/or the often slow pace of litigation.
In December 2012, Synopsys, Inc. (Synopsys) filed a lawsuit claiming patent infringement against us in federal district court in the Northern District of California, alleging that our Veloce® family of products infringes on four Synopsys United States patents. On May 2, 2013, Synopsys also filed a claim against us in federal district court in Oregon, similarly alleging that our Veloce family of products infringes on two additional Synopsys United States patents. The California case seeks compensatory damages relating to our emulation and field programmable gate arrays synthesis products; Synopsys' Oregon claims have been dismissed.
We believe these actions were filed in response to patent lawsuits we filed in 2010 and 2012 against Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), which Synopsys acquired in October 2012. Our litigation, which now alleges that EVE's Zebu emulation products infringe on one of our United States patents, was filed against EVE in federal district court in Oregon. We also filed a patent lawsuit against EVE in Tokyo district court. Our lawsuits in Oregon and Japan seek compensatory damages and an injunction against the sale of EVE emulation products. The Oregon litigation currently is scheduled for trial in September 2014, with the Japanese litigation scheduled for trial in October 2014. The California litigation is scheduled for trial in January 2015. We do not have sufficient information upon which to determine that a loss in connection with this matter is probable, reasonably possible, or estimable, and thus no liability has been established nor has a range of loss been disclosed.
(9) Stockholders' Equity
Dividends
On March 7, 2013, our Board of Directors announced the adoption of a dividend policy under which we commenced payment of quarterly cash dividends at an annual rate of $0.18 per share of common stock. On February 27, 2014, we announced an increase of the quarterly dividend to $0.05 per share. The following table summarizes the dividends declared:
|
| | | | | | | | | | | | |
Declaration Date | | Record Date | | Payment Date | | Per Share Amount | | Total Amount |
3/7/2013 | | 3/22/2013 | | 4/10/2013 | | $ | 0.045 |
| | $ | 5,064 |
|
5/23/2013 | | 6/10/2013 | | 7/1/2013 | | $ | 0.045 |
| | $ | 5,079 |
|
8/22/2013 | | 9/10/2013 | | 9/30/2013 | | $ | 0.045 |
| | $ | 5,096 |
|
11/21/2013 | | 12/10/2013 | | 1/2/2014 | | $ | 0.045 |
| | $ | 5,159 |
|
2/27/2014 | | 3/10/2014 | | 3/31/2014 | | $ | 0.05 |
| | $ | 5,778 |
|
5/22/2014 | | 6/10/2014 | | 6/30/2014 | | $ | 0.05 |
| | $ | 5,693 |
|
8/21/2014 | | 9/10/2014 | | 9/30/2014 | | $ | 0.05 |
| | |
Future declarations of quarterly dividends and the establishment of future record and payment dates are subject to the quarterly determination of our Board of Directors.
(10) Stock-Based Compensation
Stock Option and Stock Plans
Our 2010 Omnibus Incentive Plan (Incentive Plan) is administered by the Compensation Committee of our Board of Directors and permits accelerated vesting of outstanding options, restricted stock units, restricted stock awards, and other equity incentives upon the occurrence of certain changes in control of our company. Stock options and time-based restricted stock units under the Incentive Plan are generally expected to vest over four years. Stock options have an expiration date of ten years from the date of grant and an exercise price no less than the fair market value of the shares on the date of grant. Performance-based restricted stock units vest after three years depending on attainment of goals for operating income margin.
Employee Stock Purchase Plans
We have an employee stock purchase plan (ESPP) for U.S. employees and an ESPP for certain foreign subsidiary employees. The ESPPs provide for six-month offerings commencing on January 1 and July 1 of each year with purchases on June 30 and December 31 of each year. Each eligible employee may purchase up to six thousand shares of stock on each purchase date (subject to a plan limit on the total fair market value) at prices no less than 85.0% of the lesser of the fair market value of the shares on the offering date or on the purchase date.
Stock-Based Compensation Expense
The following table summarizes stock-based compensation expense recognized:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Cost of revenues | $ | 544 |
| | $ | 458 |
| | $ | 1,079 |
| | $ | 918 |
|
Operating expenses: | | | | | | | |
Research and development | 3,311 |
| | 2,543 |
| | 6,552 |
| | 5,153 |
|
Marketing and selling | 2,143 |
| | 1,771 |
| | 4,321 |
| | 3,653 |
|
General and administration | 3,162 |
| | 2,505 |
| | 5,337 |
| | 4,119 |
|
Equity plan-related compensation expense | $ | 9,160 |
| | $ | 7,277 |
| | $ | 17,289 |
| | $ | 13,843 |
|
(11) Incentive Stock Rights
Our Board of Directors has the authority to issue incentive stock in one or more series and to determine the relative rights and preferences of the incentive stock. On June 24, 2010, we adopted an Incentive Stock Purchase Rights Plan and declared a dividend distribution of one right for each outstanding share of common stock, payable to holders of record on July 6, 2010. On December 23, 2011, our Board of Directors amended the Incentive Stock Purchase Rights Plan to, among other things, extend the expiration date of the rights and increase the exercise price of each right. On June 28, 2013, our Board of Directors amended the Incentive Stock Purchase Rights Plan to extend the expiration date of the rights, change the ownership threshold for certain types of investors, increase the exercise price of each right, and add a qualifying offer provision. As long as the rights are attached to our common stock, we will issue one right with each new share of common stock so that all such shares will have attached rights. Under certain conditions, each right may be exercised to purchase 1/10,000 of a share of Series B Junior Participating Incentive Stock at a purchase price of ninety dollars, subject to adjustment. The rights are not presently exercisable and will only become exercisable if a person or group acquires or commences a tender offer to acquire 15% (20% for certain types of "passive institutional investors") or more of our common stock.
If a person or group acquires 15% (20% for certain types of "passive institutional investors") or more of our common stock, each right will be adjusted to entitle its holder to receive, upon exercise, common stock (or, in certain circumstances, other assets of ours) having a value equal to two times the exercise price of the right, or each right will be adjusted to entitle its holder to receive, upon exercise, common stock of the acquiring company having a value equal to two times the exercise price of the right, depending on the circumstances. The rights expire on June 30, 2015 and may be redeemed by us for $0.001 per right. The rights do not have voting or dividend rights and have no dilutive effect on our earnings.
(12) Net Income Per Share
We compute basic net income per share using the weighted average number of common shares outstanding during the period. We compute diluted net income per share using the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of common shares issuable upon
vesting of restricted stock units, exercise of stock options and ESPP purchase rights, and conversion of the 4.00% Debentures using the treasury stock method, if dilutive.
The following provides the computation of basic and diluted net income per share:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net income attributable to Mentor Graphics shareholders | $ | 14,172 |
| | $ | 23,982 |
| | $ | 11,621 |
| | $ | 24,187 |
|
Noncontrolling interest adjustment to redemption value | 895 |
| | (2,349 | ) | | 1,562 |
| | (1,881 | ) |
Adjusted net income attributable to Mentor Graphics shareholders | $ | 15,067 |
| | $ | 21,633 |
| | $ | 13,183 |
| | $ | 22,306 |
|
Weighted average common shares used to calculate basic net income per share | 113,868 |
| | 112,988 |
| | 114,396 |
| | 112,851 |
|
Employee stock options, restricted stock units and employee stock purchase plan | 2,683 |
| | 3,307 |
| | 2,564 |
| | 3,163 |
|
Weighted average common and potential common shares used to calculate diluted net income per share | 116,551 |
| | 116,295 |
| | 116,960 |
| | 116,014 |
|
Net income per share attributable to Mentor Graphics shareholders: | | | | | | | |
Basic net income per share | $ | 0.13 |
| | $ | 0.19 |
| | $ | 0.12 |
| | $ | 0.20 |
|
Diluted net income per share | $ | 0.13 |
| | $ | 0.19 |
| | $ | 0.11 |
| | $ | 0.19 |
|
We excluded from the computation of diluted net income per share 20 shares of common stock for stock options for the three months ended July 31, 2014 and 701 shares of common stock for stock options and ESPP purchase rights for the six months ended July 31, 2014 compared to 531 shares of common stock for stock options for the three months ended July 31, 2013 and 674 shares of common stock for stock options, restricted stock units and ESPP purchase rights for the six months ended July 31, 2013. These stock options, restricted stock units, and ESPP purchase rights were determined to be anti-dilutive as a result of applying the treasury stock method.
We increased the numerator of our basic and diluted earnings per share calculation by $895 for the three months ended July 31, 2014 and $1,562 for the six months ended July 31, 2014 for the decrease of the noncontrolling interest with redemption feature to its calculated redemption value, recorded directly to retained earnings. We decreased the numerator of our basic and diluted earnings per share calculation by $(2,349) for the three months ended July 31, 2013 and $(1,881) for the six months ended July 31, 2013 for the increase of the noncontrolling interest with redemption feature to its calculated redemption value, recorded directly to retained earnings.
We assume that the 4.00% Debentures will be settled in common stock for purposes of calculating their dilutive effect. The assumed conversion of the 4.00% Debentures was anti-dilutive and therefore excluded from the computation of diluted net income per share. The conversion feature of the 4.00% Debentures, which allow for settlement in cash or a combination of cash and common stock, are further described in Note 7. “Notes Payable.”
(13) Accumulated Other Comprehensive Income
The following table summarizes the components of accumulated other comprehensive income, net of tax:
|
| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Foreign currency translation adjustment | $ | 17,653 |
| | $ | 18,361 |
|
Unrealized gain (loss) on derivatives | (24 | ) | | 42 |
|
Pension liability | 396 |
| | 400 |
|
Total accumulated other comprehensive income | $ | 18,025 |
| | $ | 18,803 |
|
(14) Special Charges
The following is a summary of the components of special charges:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Litigation costs | $ | 4,231 |
| | $ | 3,231 |
| | $ | 8,189 |
| | $ | 5,171 |
|
Employee severance and related costs | 575 |
| | 631 |
| | 1,700 |
| | 2,710 |
|
Other costs, net | 302 |
| | (3 | ) | | 1,145 |
| | 1 |
|
Total special charges | $ | 5,108 |
| | $ | 3,859 |
| | $ | 11,034 |
| | $ | 7,882 |
|
Special charges may include expenses incurred related to certain litigation costs, employee severance, acquisitions, excess facility costs, and asset related charges.
Litigation costs consist of professional service fees for services rendered, related to patent litigation involving us, EVE, and Synopsys regarding emulation technology.
Employee severance and related costs include severance benefits, notice pay, and outplacement services. These rebalance charges generally represent the aggregate of numerous unrelated rebalance plans which impact several employee groups, none of which is individually material to our financial position or results of operations. We determine termination benefit amounts based on employee status, years of service, and local statutory requirements. We communicate termination benefits to the affected employees prior to the end of the quarter in which we record the charge.
Approximately 65% of the employee severance and related costs for the six months ended July 31, 2014 were paid during the period. We expect to pay the remainder during the fiscal year ending January 31, 2015. Substantially all of the employee severance and related costs for the six months ended July 31, 2013 were paid during the fiscal year ending January 31, 2014. There were no significant modifications to the amount of those charges.
Accrued special charges are included in accrued and other liabilities and other long-term liabilities in the condensed consolidated balance sheets. The following table shows changes in accrued special charges during the six months ended July 31, 2014:
|
| | | | | | | | | | | | | | | | | |
| Accrued special charges as of | | Charges during the six months ended | | Payments during the six months ended | | Accrued special charges as of | |
| January 31, 2014 | | July 31, 2014 | | July 31, 2014 | | July 31, 2014 | (1 | ) |
Litigation costs | $ | 4,855 |
| | $ | 8,189 |
| | $ | (9,556 | ) | | $ | 3,488 |
| |
Employee severance and related costs | 1,004 |
| | 1,700 |
| | (1,987 | ) | | 717 |
| |
Other costs, net | 1,987 |
| | 1,145 |
| | (2,018 | ) | | 1,114 |
| |
Total accrued special charges | $ | 7,846 |
| | $ | 11,034 |
| | $ | (13,561 | ) | | $ | 5,319 |
| |
| |
(1) | Of the $5,319 total accrued special charges as of July 31, 2014, $422 represents the long-term portion, which primarily includes accrued lease termination fees and other facility costs, net of sublease income and other long-term costs. The remaining balance of $4,897 represents the short-term portion of accrued special charges. |
(15) Other Income (Expense), Net
Other income (expense), net was comprised of the following:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Interest income | $ | 397 |
| | $ | 530 |
| | $ | 944 |
| | $ | 1,155 |
|
Foreign currency exchange loss | (193 | ) | | (494 | ) | | (713 | ) | | (1,869 | ) |
Other, net | (308 | ) | | (308 | ) | | (593 | ) | | (517 | ) |
Other income (expense), net | $ | (104 | ) | | $ | (272 | ) | | $ | (362 | ) | | $ | (1,231 | ) |
(16) Related Party Transactions
Certain members of our Board of Directors also serve as executive officers or directors for some of our customers. Management believes the transactions between these customers and us were carried out on an arm’s-length basis. We had
amounts receivable from these customers of $45,552 as of July 31, 2014 and $95,789 as of January 31, 2014. The following table shows revenue recognized from these customers:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Revenues from customers | $ | 5,105 |
| | $ | 7,801 |
| | $ | 11,155 |
| | $ | 36,337 |
|
Percentage of total revenues | 2.0 | % | | 3.1 | % | | 2.2 | % | | 7.6 | % |
(17) Income Taxes
The provision for income taxes was comprised of the following:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Income tax benefit | $ | (1,768 | ) | | $ | (2,338 | ) | | $ | (1,942 | ) | | $ | (1,770 | ) |
Effective tax rate | (14.7 | )% | | (10.9 | )% | | (22.1 | )% | | (8.2 | )% |
Generally, the provision for income taxes is the result of the mix of profits and losses earned in various tax jurisdictions with a broad range of income tax rates, withholding taxes (primarily in certain foreign jurisdictions), changes in tax reserves, and the application of valuation allowances on deferred tax assets. Accounting guidance for interim reporting requires that we evaluate our provision for income tax expense (benefit) based on our projected results of operations for the full year and record adjustments in each quarter. Such adjustments consider period specific items and a separate determination of tax expense for entities in our consolidated group that are projected to have losses for which no tax benefit will be recognized.
Our effective tax rate is (22.1)% for the six months ended July 31, 2014, after the inclusion of $(3,174) in net favorable period specific items. The period specific items primarily relate to reductions in liabilities for uncertain tax positions. For our full year forecast, we have projected a 10.0% effective tax rate. This rate is inclusive of period specific items recognized through July 31, 2014. Our projected rate for the full year differs from tax computed at the U.S. federal statutory rate of 35.0% primarily due to:
•The benefit of lower tax rates on earnings of foreign subsidiaries;
•Reduction in liabilities for uncertain tax positions; and
•Forecasted utilization of net operating loss carryforwards and tax credit carryforwards for which no previous benefit was recognized.
These differences are partially offset by:
•Repatriation of foreign subsidiary earnings to the U.S.;
•Non-deductible equity compensation expense; and
•Withholding taxes.
Actual results may differ significantly from our current projections. Further, our effective tax rate could fluctuate considerably on a quarterly basis and could be significantly affected to the extent our actual mix of earnings among individual jurisdictions is different than our expectations.
We determine deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities. In addition, we record deferred tax assets for net operating loss carryforwards and tax credit carryforwards. We calculate the deferred tax assets and liabilities using the enacted tax rates and laws that will be in effect when we expect the differences to reverse. A valuation allowance is recorded when it is more likely than not that all or some portion of the deferred tax asset will not be realized. Since 2004, we have determined it is uncertain whether our U.S. entity will generate sufficient taxable income and foreign source income to utilize net operating loss carryforwards, research and experimentation credit carryforwards, and foreign tax credit carryforwards before expiration. Accordingly, we recorded a valuation allowance against those deferred tax assets for which realization does not meet the more likely than not standard. We have established valuation allowances related to certain foreign deferred tax assets based on historical losses as well as future expectations in certain jurisdictions. We will continue to evaluate the realizability of the deferred tax assets on a periodic basis.
As of July 31, 2014, we had a liability of $17,937 for income taxes associated with uncertain income tax positions. Of this liability, $372 was classified as short-term liabilities in income taxes payable in our condensed consolidated balance sheet as we generally anticipate the settlement of such liabilities will require payment of cash within the next twelve months. The
remaining $17,565 of income tax associated with uncertain tax positions was classified as long-term liabilities. Certain liabilities may result in the reduction of deferred tax assets rather than settlement in cash. We are not able to reasonably estimate the timing of any cash payments required to settle the long-term liabilities and do not believe that the ultimate settlement of these liabilities will materially affect our liquidity.
(18) Supplemental Cash Flow Information
The following provides information concerning supplemental disclosures of cash flow activities:
|
| | | | | | | |
| Six months ended July 31, |
| 2014 | | 2013 |
Cash paid, net for: | | | |
Interest | $ | 5,865 |
| | $ | 6,136 |
|
Income taxes | $ | 6,408 |
| | $ | 4,932 |
|
We have an investment in Frontline PCB Solutions Limited Partnership (Frontline). We received returns on investment from Frontline of $2,900 during the six months ended July 31, 2014 and $2,800 during the six months ended July 31, 2013, which is included in net cash provided by operating activities in our condensed consolidated statement of cash flows.
(19) Segment Reporting
Our Chief Operating Decision Makers (CODMs), which consist of the Chief Executive Officer and the President, review our consolidated results within one operating segment. In making operating decisions, our CODMs primarily consider consolidated financial information accompanied by disaggregated revenue information by geographic region.
We eliminate all intercompany revenues in computing revenues by geographic regions. Revenues related to operations in the geographic regions were:
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Revenues: | | | | | | | |
United States | $ | 111,692 |
| | $ | 91,527 |
| | $ | 236,458 |
| | $ | 187,613 |
|
Europe | 55,462 |
| | 45,701 |
| | 115,611 |
| | 94,408 |
|
Japan | 20,973 |
| | 16,477 |
| | 42,254 |
| | 43,154 |
|
Pacific Rim | 62,963 |
| | 94,451 |
| | 106,676 |
| | 146,442 |
|
Other | 9,143 |
| | 5,060 |
| | 11,385 |
| | 8,114 |
|
Total revenues | $ | 260,233 |
| | $ | 253,216 |
| | $ | 512,384 |
| | $ | 479,731 |
|
For the three months ended July 31, 2014, no customer accounted for 10.0% or more of our total revenues. For the three months ended July 31, 2013, two customers each accounted for 13.0% of our total revenues. For the six months ended July 31, 2014, one customer accounted for 11.0% of our total revenues. For the six months ended July 31, 2013, no single customer accounted for 10.0% or more of our total revenues.
| |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Unless otherwise indicated, numerical references are in millions, except for percentages, per share data, and conversion rate data.
Overview
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this Form 10-Q. Certain of the statements below contain forward-looking statements. These statements are predictions based upon our current expectations about future trends and events. Actual results could vary materially as a result of certain factors, including but not limited to, those expressed in these statements. In particular, we refer you to the risks discussed in Part II, Item 1A. “Risk Factors” and in our other Securities and Exchange Commission filings, which identify important risks and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements.
We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Form 10-Q. All subsequent written or spoken forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Form 10-Q are made only as of the date of this Form 10-Q. We do not intend, and undertake no obligation, to update these forward-looking statements.
The Company
We are a supplier of electronic design automation (EDA) tools — advanced computer software and emulation hardware systems used to automate the design, analysis, and testing of complex electro-mechanical systems, electronic hardware, and embedded systems software in electronic systems and components. We market our products and services worldwide, primarily to large companies in the communications, computer, consumer electronics, semiconductor, networking, military/aerospace, multimedia, and transportation industries. Through the diversification of our customer base among these various customer markets, we attempt to reduce our exposure to fluctuations within each market. We sell and license our products through our direct sales force and a channel of distributors and sales representatives. In addition to our corporate offices in Wilsonville, Oregon, we have sales, support, product development, and professional service offices worldwide.
We focus on products and design platforms where we have or believe we can attain leading market share. Part of this approach includes developing new applications and exploring new markets where EDA companies have not generally participated. We believe this strategy leads to a more diversified product and customer mix and can help reduce the volatility of our business and our risk as a creditor, while increasing our potential for growth.
We derive system and software revenues primarily from the sale of term software license contracts, which are typically three to four years in length. We generally recognize revenue for these arrangements upon product delivery at the beginning of the license term. Larger enterprise-wide customer contracts, which are approximately 50% or more of our system and software revenue, drive the majority of our period-to-period revenue variances. We identify term licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues primarily include short-term term licenses. For these reasons, the timing of large contract renewals, customer circumstances, and license terms are the primary drivers of revenue changes from period to period, with revenue changes also being driven by new contracts and additional purchases under existing contracts, to a lesser extent.
The EDA industry is competitive and is characterized by very strong leadership positions in specific segments of the EDA market. These strong leadership positions can be maintained for significant periods of time as the software can be difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from areas in which we are the leader. We expect to continue our strategy of developing high quality tools with number one market share potential, rather than being a broad-line supplier with undifferentiated product offerings. This strategy allows us to focus investment in areas where customer needs are greatest and where we have the opportunity to build significant market share.
Our products and services are dependent to a large degree on new design projects initiated by customers in the integrated circuit (IC) and electronics system industries. These industries can be cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. Furthermore, extended economic downturns can result in reduced funding for development due to
downsizing and other business restructurings. These pressures are offset by the need for the development and introduction of next generation products once an economic recovery occurs.
Known Trends and Uncertainties Impacting Future Results of Operations
Our revenue has historically fluctuated quarterly and has generally been the highest in the fourth quarter of our fiscal year due to our customers’ corporate calendar year-end spending trends and the timing of contract renewals.
Ten accounts make up approximately 30% of our receivables, including both short and long-term balances. We have not experienced and do not presently expect to experience collection issues with these customers.
Net of reserves, we have no receivables greater than 60 days past due, and continue to experience no difficulty in factoring our high quality receivables.
Bad debt expense recorded for the first six months of fiscal 2015 was not material. However, we do have exposures within our receivables portfolio to customers with weak credit ratings. These receivable balances do not represent a material portion of our portfolio but could have a material adverse effect on earnings in any given quarter, should significant additional allowances for doubtful accounts be necessary.
Bookings during the first six months of fiscal 2015 decreased by approximately 30% compared to the first six months of fiscal 2014 primarily due to a decrease in emulation bookings. Bookings are the value of executed orders during a period for which revenue has been or will be recognized within six months for software products and within twelve months for emulation hardware systems, professional services, and training. Ten customers accounted for approximately 35% of total bookings for the first six months of fiscal 2015 compared to 65% for the first six months of fiscal 2014. The number of new customers during the first six months of fiscal 2015 increased approximately 10% from the levels experienced during the first six months of fiscal 2014.
Product Development
During the first six months of fiscal 2015, we continued to execute our strategy of focusing on technical challenges encountered by customers, as well as building upon our well-established product families. We believe that customers, faced with leading-edge design challenges in creating new products, generally choose the best EDA products in each category to build their design environment. Through both internal development and strategic acquisitions, we have focused on areas where we believe we can build a leading market position or extend an existing leading market position.
We believe that the development and commercialization of EDA software tools is generally a three to five year process with limited customer adoption and sales in the first years of tool availability. Once tools are adopted, however, their life spans tend to be long. During the first six months of fiscal 2015, we introduced new products and upgrades to existing products and did not have any significant products reaching the end of their useful economic life.
Critical Accounting Policies
We base our discussion and analysis of our financial condition and results of operations upon our condensed consolidated financial statements which have been prepared in accordance with United States (U.S.) generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our estimates on an on-going basis. We base our estimates on historical experience, current facts, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs, and expenses that are not readily apparent from other sources. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.
We believe that the accounting for revenue recognition, valuation of trade accounts receivable, income taxes, business combinations, goodwill, intangible assets, long-lived assets, special charges, and stock-based compensation are the critical accounting estimates and judgments used in the preparation of our condensed consolidated financial statements. For further discussion of our critical accounting policies, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in Part II of our Annual Report on Form 10-K for the year ended January 31, 2014.
RESULTS OF OPERATIONS
Revenues and Gross Profit
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
System and software revenues | $ | 149.5 |
| | — | % | | $ | 150.2 |
| | $ | 297.7 |
| | 9 | % | | $ | 273.5 |
|
System and software gross profit | $ | 131.5 |
| | (2 | )% | | $ | 134.3 |
| | $ | 251.3 |
| | 2 | % | | $ | 247.4 |
|
Gross profit percent | 88 | % | | | | 89 | % | | 84 | % | | | | 90 | % |
Service and support revenues | $ | 110.7 |
| | 7 | % | | $ | 103.0 |
| | $ | 214.7 |
| | 4 | % | | $ | 206.2 |
|
Service and support gross profit | $ | 79.8 |
| | 8 | % | | $ | 74.1 |
| | $ | 154.7 |
| | 5 | % | | $ | 147.3 |
|
Gross profit percent | 72 | % | | | | 72 | % | | 72 | % | | | | 71 | % |
Total revenues | $ | 260.2 |
| | 3 | % | | $ | 253.2 |
| | $ | 512.4 |
| | 7 | % | | $ | 479.7 |
|
Total gross profit | $ | 211.3 |
| | 1 | % | | $ | 208.4 |
| | $ | 406.0 |
| | 3 | % | | $ | 394.7 |
|
Gross profit percent | 81 | % | | | | 82 | % | | 79 | % | | | | 82 | % |
System and Software
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
Upfront license revenues | $ | 124.9 |
| | (2 | )% | | $ | 127.6 |
| | $ | 249.7 |
| | 10 | % | | $ | 227.9 |
|
Ratable license revenues | 24.6 |
| | 9 | % | | 22.6 |
| | 48.0 |
| | 5 | % | | 45.6 |
|
Total system and software revenues | $ | 149.5 |
| | — | % | | $ | 150.2 |
| | $ | 297.7 |
| | 9 | % | | $ | 273.5 |
|
We derive system and software revenues from the sale of licenses of software products and emulation hardware systems, including finance fee revenues from our long-term installment receivables resulting from term product sales. Upfront license revenues consist of perpetual licenses and term licenses for which we recognize revenue upon product delivery at the start of a license term. We identify term licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues primarily consist of short-term term licenses and finance fees from the accretion of the discount on long-term installment receivables.
Ten customers accounted for approximately 55% of system and software revenues for the three months ended July 31, 2014 and 45% for the six months ended July 31, 2014 compared to approximately 70% for the three months ended July 31, 2013 and 55% for the six months ended July 31, 2013.
System and software revenues increased for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 primarily as a result of increased sales of emulation hardware systems.
For the three months ended July 31, 2014, no single customer accounted for 10% or more of total revenues. For the three months ended July 31, 2013, two customers each accounted for 13% of total revenues. For the six months ended July 31, 2014, one customer accounted for 11% of total revenues. For the six months ended July 31, 2013, no single customer accounted for 10% or more of total revenues.
System and software gross profit percent was lower for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 primarily due to increased sales of lower-margin emulation hardware systems.
Service and Support
We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which include consulting, training, and other services. Professional services are lower margin offerings which are staffed according to fluctuations in demand. Support services operate under a less variable cost structure.
The increase in service and support revenues for the three and six months ended July 31, 2014 compared to the three and six months ended July 31, 2013 was primarily due to increased support revenues resulting from an increase in our installed base.
Geographic Revenues Information
Revenue by Geography
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
North America | $ | 120.8 |
| | 25 | % | | $ | 96.6 |
| | $ | 247.8 |
| | 27 | % | | $ | 195.7 |
|
Europe | 55.4 |
| | 21 | % | | 45.7 |
| | 115.6 |
| | 22 | % | | 94.4 |
|
Japan | 21.0 |
| | 27 | % | | 16.5 |
| | 42.3 |
| | (2 | )% | | 43.2 |
|
Pacific Rim | 63.0 |
| | (33 | )% | | 94.4 |
| | 106.7 |
| | (27 | )% | | 146.4 |
|
Total revenues | $ | 260.2 |
| | 3 | % | | $ | 253.2 |
| | $ | 512.4 |
| | 7 | % | | $ | 479.7 |
|
The changes in revenues in all geographic regions for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 were primarily due to the timing of contract renewals. The changes in revenues in North America and Europe for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 were primarily due to increased sales of emulation hardware systems and the timing of contract renewals. The change in revenues in the Pacific Rim for the six months ended July 31, 2014 compared to the six months ended July 31, 2013 was primarily due to the timing of contract renewals.
We recognize additional revenues in periods when the U.S. dollar weakens in value against foreign currencies. Likewise, we recognize lower revenues in periods when the U.S. dollar strengthens in value against foreign currencies. For the three and six months ended July 31, 2014, approximately one-third of European and approximately 90% of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies.
Foreign currency had a nominal impact for the three months ended July 31, 2014 compared to the three months ended July 31, 2013, as the unfavorable impact of the weak Japanese yen was offset by the favorable impact of the strong euro. Foreign currency had an unfavorable impact of $1.6 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013, primarily as a result of the strengthening of the U.S. dollar against the Japanese yen, partially offset by the favorable impact of the strengthening of the euro against the U.S. dollar.
For additional description of how changes in foreign exchange rates affect our condensed consolidated financial statements, see discussion in Part I, “Item 3. Quantitative and Qualitative Disclosures About Market Risk –Foreign Currency Risk.”
Revenue by Category
We segregate revenues into five categories of similar products and services. Each category includes both product and related support revenues. Revenues for each category as a percent of total revenues are as follows (percentages rounded to the nearest 5%):
|
| | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Revenues: | | | | | | | |
IC Design to Silicon | 30 | % | | 50 | % | | 25 | % | | 45 | % |
Scalable Verification | 25 | % | | 20 | % | | 30 | % | | 20 | % |
Integrated System Design | 25 | % | | 20 | % | | 25 | % | | 25 | % |
New & Emerging Products | 10 | % | | 5 | % | | 10 | % | | 5 | % |
Services & Other | 10 | % | | 5 | % | | 10 | % | | 5 | % |
Total revenues | 100 | % | | 100 | % | | 100 | % | | 100 | % |
Operating Expenses
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
Research and development | $ | 87.5 |
| | 9 | % | | $ | 80.3 |
| | $ | 172.0 |
| | 8 | % | | $ | 160.0 |
|
Marketing and selling | 82.3 |
| | 3 | % | | 79.8 |
| | 166.9 |
| | 5 | % | | 158.9 |
|
General and administration | 19.5 |
| | 13 | % | | 17.2 |
| | 37.2 |
| | 11 | % | | 33.5 |
|
Equity in earnings of Frontline | (2.0 | ) | | 100 | % | | (1.0 | ) | | (3.4 | ) | | 162 | % | | (1.3 | ) |
Amortization of intangible assets | 2.0 |
| | 25 | % | | 1.6 |
| | 3.8 |
| | 19 | % | | 3.2 |
|
Special charges | 5.1 |
| | 31 | % | | 3.9 |
| | 11.0 |
| | 39 | % | | 7.9 |
|
Total operating expenses | $ | 194.4 |
| | 7 | % | | $ | 181.8 |
| | $ | 387.5 |
| | 7 | % | | $ | 362.2 |
|
Selected Operating Expenses as a Percentage of Total Revenues
|
| | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Research and development | 34 | % | | 32 | % | | 34 | % | | 33 | % |
Marketing and selling | 32 | % | | 32 | % | | 33 | % | | 33 | % |
General and administration | 7 | % | | 7 | % | | 7 | % | | 7 | % |
Total selected operating expenses | 73 | % | | 71 | % | | 74 | % | | 73 | % |
Research and Development
Research and development expenses increased by $7.2 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and $12.0 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The components of this increase are summarized as follows:
|
| | | | | | | |
| Change |
| Three months ended July 31, | | Six months ended July 31, |
Salaries, variable compensation, and benefits expenses | $ | 2.8 |
| | $ | 5.1 |
|
Expenses associated with acquired businesses | 3.8 |
| | 6.0 |
|
Other expenses | 0.6 |
| | 0.9 |
|
Total change in research and development expenses | $ | 7.2 |
| | $ | 12.0 |
|
Marketing and Selling
Marketing and selling expenses increased by $2.5 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and increased by $8.0 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The components of these changes are summarized as follows:
|
| | | | | | | |
| Change |
| Three months ended July 31, | | Six months ended July 31, |
Salaries, variable compensation, and benefits expenses | $ | (0.3 | ) | | $ | 4.3 |
|
Expenses associated with acquired businesses | 1.6 |
| | 2.4 |
|
Bad debt expense | (0.2 | ) | | (1.5 | ) |
Other expenses | 1.4 |
| | 2.8 |
|
Total change in marketing and selling expenses | $ | 2.5 |
| | $ | 8.0 |
|
General and Administration
General and administration expenses increased by $2.3 for the three months ended July 31, 2014 compared to the three months ended July 31, 2013 and $3.6 for the six months ended July 31, 2014 compared to the six months ended July 31, 2013.
|
| | | | | | | |
| Change |
| Three months ended July 31, | | Six months ended July 31, |
Salaries, variable compensation, and benefits expenses | $ | 0.6 |
| | $ | 0.7 |
|
Professional services | 0.9 |
| | 1.2 |
|
Stock compensation | 0.7 |
| | 1.2 |
|
Other expenses | 0.1 |
| | 0.5 |
|
Total change in general and administrative expenses | $ | 2.3 |
| | $ | 3.6 |
|
We incur a substantial portion of our operating expenses outside the U.S. in various foreign currencies. We recognize additional operating expense in periods when the U.S. dollar weakens in value against foreign currencies and lower operating expenses in periods when the U.S. dollar strengthens in value against foreign currencies. We experienced unfavorable currency movements in total operating expenses of approximately $(1.7) for the three months ended July 31, 2014 compared to the three months ended July 31, 2013, and approximately $(1.2) for the six months ended July 31, 2014 compared to the six months ended July 31, 2013. The impact of these currency movements is reflected in the changes in operating expenses detailed above.
Equity in Earnings of Frontline
We have a 50% interest in a joint venture, Frontline P.C.B. Solutions Limited Partnership (Frontline). Frontline is owned equally by Orbotech, Ltd., an Israeli company, and us.
Frontline reports on a calendar year basis; therefore we record our interest in the earnings of Frontline on a one-month lag. The following presents the summarized financial information of our 50% interest in Frontline for the three and six months ended June 30, 2014 and 2013:
|
| | | | | | | | | | | | | | | |
| Three months ended June 30, | | Six months ended June 30, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net income, as reported | $ | 2.0 |
| | $ | 1.2 |
| | $ | 3.5 |
| | $ | 2.3 |
|
Amortization of purchased technology and other identified intangible assets | — |
| | (0.2 | ) | | (0.1 | ) | | (1.0 | ) |
Equity in earnings of Frontline | $ | 2.0 |
| | $ | 1.0 |
| | $ | 3.4 |
| | $ | 1.3 |
|
Special Charges
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
Litigation costs | $ | 4.2 |
| | 27 | % | | $ | 3.3 |
| | $ | 8.2 |
| | 58 | % | | $ | 5.2 |
|
Employee severance and related costs | 0.6 |
| | — | % | | 0.6 |
| | 1.7 |
| | (37 | )% | | 2.7 |
|
Other costs, net | 0.3 |
| | — | % | | — |
| | 1.1 |
| | — | % | | — |
|
Total special charges | $ | 5.1 |
| | 31 | % | | $ | 3.9 |
| | $ | 11.0 |
| | 39 | % | | $ | 7.9 |
|
Special charges may include expenses incurred related to certain litigation costs, employee severance, acquisitions, excess facility costs, and asset related charges.
Litigation costs consist of professional service fees for services rendered, related to patent litigation involving us, Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), and Synopsys, Inc. regarding emulation technology.
Employee severance and related costs include severance benefits, notice pay, and outplacement services. These rebalance charges generally represent the aggregate of numerous unrelated rebalance plans which impact several employee groups, none of which is individually material to our financial position or results of operations. We determine termination benefit amounts based on employee status, years of service, and local statutory requirements. We communicate termination benefits to the affected employees prior to the end of the quarter in which we record the charge.
Provision for Income Taxes
|
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | Change | | 2013 | | 2014 | | Change | | 2013 |
Income tax benefit | $ | (1.8 | ) | | (22 | )% | | $ | (2.3 | ) | | $ | (1.9 | ) | | 6 | % | | $ | (1.8 | ) |
Generally, the provision for income taxes is the result of the mix of profits and losses earned in various tax jurisdictions with a broad range of income tax rates, withholding taxes (primarily in certain foreign jurisdictions), changes in tax reserves, and the application of valuation allowances on deferred tax assets. The provision considers that a significant amount of our earnings are in certain foreign operations, including our Irish subsidiaries. Accounting guidance for interim reporting requires that we evaluate our provision for income tax expense (benefit) based on our projected results of operations for the full year, and record adjustments in each quarter. Such adjustments consider period specific items and a separate determination of tax expense for entities in our consolidated group that are projected to have losses for which no tax benefit will be recognized.
|
| | | | | | | | | | | | | | | |
| Three months ended July 31, | | Six months ended July 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Effective tax rate | (15 | )% | | (11 | )% | | (22 | )% | | (8 | )% |
Net period specific items benefit | $ | (3.2 | ) | | $ | (4.9 | ) | | $ | (3.2 | ) | | $ | (4.5 | ) |
Effective tax rate without period specific items | 12 | % | | 12 | % | | 14 | % | | 13 | % |
For the six months ended July 31, 2014, we have a 14% effective tax rate without period specific items. This current period effective tax rate differs from our effective tax rate for the six months ended July 31, 2013 due to the application of the accounting guidance for interim periods with respect to jurisdictions with projected losses before tax for which no tax benefits will be recognized and the variability in the mix of profits and losses earned in various tax jurisdictions with a broad range of income tax rates.
For our full year forecast, we have projected a 10% effective tax rate. This rate is inclusive of period specific items recognized through July 31, 2014. Our projected rate differs from tax computed at the U.S. federal statutory rate of 35% primarily due to:
| |
• | The benefit of lower tax rates on earnings of foreign subsidiaries; |
| |
• | Reduction in liabilities for uncertain tax positions; and |
| |
• | Forecasted utilization of net operating loss carryforwards and tax credit carryforwards for which no benefit was previously recognized. |
These differences are partially offset by:
| |
• | Repatriation of foreign subsidiary earnings to the U.S.; |
| |
• | Non-deductible equity compensation expense; and |
We have not provided for income taxes on the undistributed earnings of our foreign subsidiaries to the extent they are considered permanently reinvested outside of the U.S. Upon repatriation, some of these earnings may be sheltered by U.S. loss carryforwards, research and development credits and foreign tax credits, which may reduce the federal tax liability associated with any future foreign dividend. Where the earnings of our foreign subsidiaries are not treated as permanently reinvested, we have considered the impact in our provision.
We are subject to income taxes in the U.S. and in numerous foreign jurisdictions. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. The statute of limitations for adjustments to our historic tax obligations varies from jurisdiction to jurisdiction. In some cases it may be extended or be unlimited. Furthermore, net operating loss and tax credit carryforwards may be subject to adjustment after the expiration of the statute of limitations of the year such net operating losses and tax credits originated. Our larger jurisdictions generally provide for a statute of limitations from three to five years. For U.S. federal income tax purposes, the tax years which remain open for examination are fiscal years 2011 and forward, although net operating loss and tax credit carryforwards from all years are subject to examination and adjustment for three years following the year in which they were utilized. We are currently under examination in various jurisdictions. The examinations are in different stages and timing of their resolution is difficult to predict. The statute of limitations remains open for years on or after fiscal 2010 in Ireland.
We have reserves for taxes to address potential exposures involving tax positions that are being challenged or that could be challenged by taxing authorities even though we believe that the positions we have taken are appropriate. We believe our tax reserves are adequate to cover potential liabilities. We review the tax reserves quarterly and as circumstances warrant and adjust
the reserves as events occur that affect our potential liability for additional taxes. Many of these events cannot be predicted, such as clarifications of tax law by administrative or judicial means, and it is often difficult to predict the final outcome or timing of resolution of any particular tax matter. To the extent that uncertain tax positions resolve in our favor, it could have a positive impact on our effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Our primary ongoing cash requirements are for product development, operating activities, capital expenditures, debt service, and acquisition opportunities that may arise. Our primary sources of liquidity are cash generated from operations and borrowings on our revolving credit facility.
We currently have sufficient funds for domestic operations and do not anticipate the need to repatriate funds associated with our permanently reinvested foreign earnings for use in U.S. operations. As of July 31, 2014, we have cash totaling $159.3 held by our foreign subsidiaries. A significant portion of our offshore cash is accessible without a significant tax cost as the repatriation of foreign earnings may be sheltered from U.S. federal tax by net operating losses and tax credits. To the extent our foreign earnings are not permanently reinvested, we have provided for the tax consequences that would ensue upon their repatriation. In the event funds which are treated as permanently reinvested are repatriated, we may be required to accrue and pay additional taxes to repatriate these funds.
To date, we have experienced no loss or lack of access to our invested cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets.
At any point in time, we have significant balances in operating accounts that are with individual third-party financial institutions, which may exceed the Federal Deposit Insurance Corporation insurance limits or other regulatory insurance program limits. We monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate; however, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets.
We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis:
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• | Anticipated cash flows from operating activities, including the effects of selling and financing customer term receivables; |
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• | Amounts available under existing revolving credit facilities; and |
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• | Other available financing sources, such as the issuance of debt or equity securities. |
We have experienced no difficulties to date in raising debt. However, capital markets have been volatile, and we cannot assure that we will be able to raise debt or equity capital on acceptable terms, if at all.
Cash Flow Information
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| | | | | | | |
| Six months ended July 31, |
| 2014 | | 2013 |
Cash provided by operating activities | $ | 38.6 |
| | $ | 35.2 |
|
Cash used in investing activities | $ | (85.1 | ) | | $ | (21.5 | ) |
Cash used in financing activities | $ | (72.7 | ) | | $ | (26.0 | ) |
Operating Activities
Cash flows from operating activities consist of our net income adjusted for certain non-cash items and changes in operating assets and liabilities.
Trade Accounts and Term Receivables
Our cash flows from operating activities are significantly influenced by the payment terms on our license agreements and by our sales of qualifying accounts receivable. Our customers’ inability to fulfill payment obligations could adversely affect our cash flow. Though we have not, to date, experienced a material level of defaults, material payment defaults by our customers as a result of negative economic conditions or otherwise could have a material adverse effect on our financial condition. We monitor our accounts receivable portfolio for customers with low or declining credit ratings and increase our collection efforts when necessary. Trade accounts and term receivables consisted of the following:
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| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Trade accounts receivable, net | $ | 423.7 |
| | $ | 454.5 |
|
Term receivables, short-term (included in trade accounts receivable on the balance sheet) | $ | 311.2 |
| | $ | 274.7 |
|
Term receivables, long-term | $ | 236.7 |
| | $ | 270.4 |
|
Average days sales outstanding including the short-term portion of term receivables | 147 days |
| | 102 days |
|
Average days sales outstanding in trade accounts receivable, excluding the short-term portion of term receivables | 39 days |
| | 40 days |
|
The increase in the average days sales outstanding in term receivables, short-term as of July 31, 2014, was primarily due to a decrease in revenue in the second quarter of fiscal 2015 compared to the fourth quarter of fiscal 2014.
Term receivables are attributable to multi-year term license sales agreements. We include amounts for term agreements that are due within one year in trade accounts receivable, net, on our balance sheet and balances that are due in more than one year in term receivables, long-term. We use term agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. Total term receivables were $547.9 as of July 31, 2014 compared to $545.0 as of January 31, 2014.
We enter into agreements to sell qualifying accounts receivable from time to time to certain financing institutions on a non-recourse basis. We received net proceeds from the sale of receivables of $11.4 for the six months ended July 31, 2014 compared to $9.6 for the six months ended July 31, 2013. We continue to have no difficulty in factoring receivables and continue to evaluate the economics of the sale of accounts receivable. We have not set a target for the sale of accounts receivables for the remainder of fiscal 2015.
Accrued Payroll and Related Liabilities
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| | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
Accrued payroll and related liabilities | $ | 51.5 |
| | $ | 102.8 |
|
The decrease in accrued payroll and related liabilities as of July 31, 2014 compared to January 31, 2014 was primarily due to incentive payments made during fiscal 2015 on fiscal 2014 year-end accruals. We generally experience higher accrued payroll and related liability balances at year-end primarily due to increased commission accruals associated with an increase in revenues in the fourth quarter. Additionally, we generally experience an increase in variable compensation at year-end due to the full year achievement of results.
Investing Activities
Cash used in investing activities for the six months ended July 31, 2014 primarily consisted of cash paid for acquisitions of businesses and capital expenditures.
On March 20, 2014, we acquired for cash all of the outstanding common shares of Berkeley Design Automation, Inc. (BDA), a leader in nanometer analog, mixed signal, and radio frequency circuit verification for total consideration of $51.3, including current period cash payments of $46.8 ($45.5, net of $1.3 of acquired cash). The acquisition of BDA aligns with Mentor's goal to deliver technologies with superior performance and automation for the growing challenges of Analog/Mixed-Signal verification.
During the three months ended July 31, 2014, we acquired two privately-held companies which were accounted for as business combinations for total consideration of $39.1, including current period cash payments of $33.9 ($30.4, net of $3.5 of acquired
cash). We plan to finance future business acquisitions through cash and possible common stock issuances. The cash expected to be utilized includes cash on hand, cash generated from operating activities, and borrowings on our revolving credit facility.
Expenditures for property, plant, and equipment were $13.3 for the six months ended July 31, 2014 compared to $13.8 for the six months ended July 31, 2013. The expenditures for property, plant, and equipment for the six months ended July 31, 2014 were primarily a result of spending on information technology and infrastructure improvements within facilities. We expect total capital expenditures for property, plant, and equipment for fiscal 2015 to be approximately $35.0. We plan to finance these capital expenditures using cash on hand.
Financing Activities
For the six months ended July 31, 2014, cash used in financing activities consisted primarily of repurchases of our common stock, a net decrease in short-term borrowings, and the payment of dividends.
In April 2014, our previous three-year share repurchase program expired. On June 12, 2014, we announced a new share repurchase program approved by our Board of Directors, authorizing the repurchase of up to $200 million of our common stock over a three-year period. During the six months ended July 31, 2014, we repurchased 3.2 shares of common stock for $70.1 under these programs. As of July 31, 2014, $175.0 remained available for purchase under the program approved in June 2014.
During the six months ended July 31, 2014, we paid two quarterly dividends of $0.05 per share of outstanding common stock for a total of $11.5. On August 21, 2014, we announced a quarterly dividend of $0.05 per share of outstanding common stock, payable on September 30, 2014 to shareholders of record as of the close of business on September 10, 2014. Future declarations of quarterly dividends and the establishment of future record and payment dates are subject to the quarterly determination of our Board of Directors.
The terms of our revolving credit facility limit the combination of the amount of our common stock we can repurchase and the amount of dividends we can pay to $50.0 plus 70% of our cumulative net income for periods after January 31, 2011. An additional $71.8 is available for common stock purchases or dividend payments under this limit as of July 31, 2014.
Other factors affecting liquidity and capital resources
4.00% Convertible Subordinated Debentures due 2031
In April 2011, we issued $253.0 of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures). Interest on the 4.00% Debentures is payable semi-annually in April and October.
As of July 31, 2014, each one thousand dollars in principal amount of the 4.00% Debentures is convertible, under certain circumstances, into 49.365 shares of our common stock (equivalent to a conversion price of $20.26 per share) for a total of 12.5 shares. These circumstances include:
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• | The market price of our common stock exceeding 120% of the conversion price, or $24.31 per share as of July 31, 2014, for at least 20 of the last 30 trading days in the previous fiscal quarter; |
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• | A call for redemption of the 4.00% Debentures; |
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• | Specified distributions to holders of our common stock; |
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• | If a fundamental change, such as a change of control, occurs; |
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• | During the two months prior to, but not on, the maturity date; or |
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• | The market price of the 4.00% Debentures declining to less than 98% of the value of the common stock into which the 4.00% Debentures are convertible. |
Upon conversion of any 4.00% Debentures, a holder will receive:
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(i) | Cash for the lesser of the principal amount of the 4.00% Debentures that are converted or the value of the converted shares; and |
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(ii) | Cash or shares of common stock, at our election, for the excess, if any, of the value of the converted shares over the principal amount. |
If a holder elects to convert their 4.00% Debentures in connection with a fundamental change in the company that occurs prior to April 5, 2016, the holder will also be entitled to receive a make whole premium upon conversion in some circumstances.
As the result of us declaring cash dividends during the fiscal year ended January 31, 2014 and the six months ended July 31, 2014, the initial conversion rate for the 4.00% Debentures of 48.6902 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.54 per share of our common stock) has been adjusted to 49.365 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.26 per share of our common stock).
We may redeem some or all of the 4.00% Debentures for cash on or after April 5, 2016 at the following redemption prices expressed as a percentage of principal, plus any accrued and unpaid interest:
|
| | |
Period | Redemption Price |
Beginning on April 5, 2016 and ending on March 31, 2017 | 101.143 | % |
Beginning on April 1, 2017 and ending on March 31, 2018 | 100.571 | % |
On April 1, 2018 and thereafter | 100.000 | % |
The holders, at their option, may redeem the 4.00% Debentures in whole or in part for cash on April 1, 2018, April 1, 2021, and April 1, 2026, and in the event of a fundamental change in the company. In each case, the repurchase price will be 100% of the principal amount of the 4.00% Debentures plus any accrued and unpaid interest.
For further information on the 4.00% Debentures, see Note 7. “Notes Payable” in Part I, Item 1. “Financial Statements.”
Revolving Credit Facility
We have a revolving credit facility with a maximum borrowing capacity of $125.0, which expires on May 24, 2017. We have the option to pay interest based on:
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(i) | London Interbank Offered Rate (LIBOR) with varying maturities commensurate with the borrowing period we select, plus a spread of between 2.00% and 2.50% based on a pricing grid tied to a financial covenant; or |
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(ii) | A base rate plus a spread of between 1.00% and 1.50%, based on a pricing grid tied to a financial covenant. |
As a result of these interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. In addition, commitment fees are payable on the unused portion of the revolving credit facility at rates between 0.30% and 0.40% based on a pricing grid tied to a financial covenant. We had no borrowings against the revolving credit facility during the six months ended July 31, 2014 and 2013.
This revolving credit facility contains certain financial and other covenants, including a limit on the aggregate amount we can pay for dividends and repurchases of our stock over the term of the facility.
We were in compliance with all financial covenants as of July 31, 2014. If we fail to comply with the financial covenants and do not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility.
For further information on our revolving credit facility, see Note 6. “Short-Term Borrowings” in Part I, Item 1. “Financial Statements.”
OUTLOOK FOR FISCAL 2015
We expect revenues for the third quarter of fiscal 2015 to be approximately $275.0 with earnings per share for the same period of approximately $0.07 per diluted share. For the full fiscal year 2015, we expect revenues of approximately $1.237 billion with earnings per share of $1.37 per diluted share.
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
Unless otherwise indicated, all numerical references in tables are in millions, except interest rates and contract rates.
Interest Rate Risk
We are exposed to interest rate risk primarily through our investment portfolio, short-term borrowings, and notes payable. We do not use derivative financial instruments for speculative or trading purposes.
We place our investments in instruments that meet high quality credit standards, as specified in our investment policy. The policy also limits the amount of credit exposure to any one issuer and type of instrument. We do not expect any material loss with respect to our investment portfolio.
The table below presents the carrying amount and related weighted-average fixed interest rates for our investment portfolio. The carrying amount approximates fair value as of July 31, 2014. In accordance with our investment policy, all short-term investments mature in twelve months or less.
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| | | | | |
Principal (notional) amounts in United States dollars | Carrying Amount | | Average Fixed Interest Rate |
Cash equivalents - fixed rate | $ | 4.8 |
| | 5.01% |
We have convertible subordinated debentures with a principal balance of $253.0 outstanding with a fixed interest rate of 4.00% as of July 31, 2014 and July 31, 2013. Generally, interest rate changes for fixed rate debt affect the fair value of the debt but do not affect future earnings or cash flow.
We have a syndicated, senior, unsecured, revolving credit facility, which expires on May 24, 2017. Borrowings under the revolving credit facility are permitted to a maximum of $125.0. Under this revolving credit facility, we have the option to pay interest based on:
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(i) | London Interbank Offered Rate (LIBOR) with varying maturities commensurate with the borrowing period we select, plus a spread of between 2.00% and 2.50% based on a pricing grid tied to a financial covenant; or |
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(ii) | A base rate plus a spread of between 1.00% and 1.50%, based on a pricing grid tied to a financial covenant. |
As a result of the interest rate options, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. This revolving credit facility contains certain financial and other covenants, including restrictions on the payment of dividends. As of July 31, 2014 and 2013, we had no balance outstanding against this revolving credit facility. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow. For further information on our revolving credit facility, see Note 6. “Short-Term Borrowings” in Part I, Item 1. “Financial Statements.”
We had other short-term borrowings of $1.0 outstanding as of July 31, 2014 and $1.1 as of July 31, 2013 with variable rates based on market indexes. Interest rate changes for variable interest rate debt generally do not affect the fair market value, but do affect future earnings and cash flow.
Foreign Currency Risk
We transact business in various foreign currencies and have established a foreign currency hedging program to hedge certain foreign currency forecasted transactions and exposures from existing assets and liabilities. Our derivative instruments consist of short-term foreign currency exchange contracts, with a duration period of a year or less. We enter into contracts with counterparties who are major financial institutions and, as such we do not expect material losses as a result of defaults by our counterparties. We do not hold or issue derivative financial instruments for speculative or trading purposes.
We enter into foreign currency forward contracts to protect against currency exchange risk associated with expected future cash flows. Our practice is to hedge a majority of our existing material foreign currency transaction exposures, which generally represent the excess of expected euro and British pound denominated expenses over expected euro and British pound denominated revenues, and the excess of Japanese yen denominated revenues over expected Japanese yen denominated expenses. We also enter into foreign currency forward contracts to protect against currency exchange risk associated with existing monetary assets and liabilities.
The following table provides volume information about our foreign currency forward program. The information provided is in United States dollar equivalent amounts. The table presents the gross notional amounts, at contract exchange rates, and the weighted average contractual foreign currency exchange rates. These forward contracts mature within the next twelve months.
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| | | | | | | | | | | | | |
As of | July 31, 2014 | | January 31, 2014 |
| Gross Notional Amount | | Weighted Average Contract Rate | | Gross Notional Amount | | Weighted Average Contract Rate |
Forward Contracts: | | | | | | | |
Japanese yen | $ | 65.1 |
| | 101.78 |
| | $ | 54.7 |
| | 103.91 |
|
Euro | 34.6 |
| | 0.74 |
| | 29.6 |
| | 0.74 |
|
British pound | 28.5 |
| | 0.59 |
| | 22.1 |
| | 0.61 |
|
Indian rupee | 15.0 |
| | 60.38 |
| | 12.0 |
| | 62.03 |
|
Swedish krona | 11.3 |
| | 6.83 |
| | 12.7 |
| | 6.47 |
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Other (1) | 39.6 |
| | — |
| | 38.3 |
| | — |
|
Total forward contracts | $ | 194.1 |
| | | | $ | 169.4 |
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(1) | Other includes the Israeli shekel, Chinese yuan, Canadian dollar, Armenian dollar, Russian ruble, Swiss franc, Korean won, Danish kroner, Norwegian kroner, Polish zloty, Taiwan dollar, Hungarian forint, and Singapore dollar. |
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Item 4. | Controls and Procedures |
(1) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (Exchange Act), that are designed to ensure that information required to be disclosed in our Exchange Act reports is accurately recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.
(2) Changes in Internal Controls Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In December 2012, Synopsys, Inc. (Synopsys) filed a lawsuit claiming patent infringement against us in federal district court in the Northern District of California, alleging that our Veloce® family of products infringes on four Synopsys United States patents. On May 2, 2013, Synopsys also filed a claim against us in federal district court in Oregon, similarly alleging that our Veloce family of products infringes on two additional Synopsys United States patents. The California case seeks compensatory damages relating to our emulation and field programmable gate arrays synthesis products; Synopsys' Oregon claims have been dismissed.
We believe these actions were filed in response to patent lawsuits we filed in 2010 and 2012 against Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), which Synopsys acquired in October 2012. Our litigation, which now alleges that EVE’s Zebu emulation products infringe on one of our United States patents, was filed against EVE in federal district court in Oregon. We also filed a patent lawsuit against EVE in Tokyo district court. Our lawsuits in Oregon and Japan seek compensatory damages and an injunction against the sale of EVE emulation products. The Oregon litigation currently is scheduled for trial in September 2014, with the Japanese litigation scheduled for trial in October 2014. The California litigation is scheduled for trial in January 2015. We do not have sufficient information upon which to determine that a loss in connection with this matter is probable, reasonably possible, or estimable, and thus no liability has been established nor has a range of loss been disclosed.
Item 1A. Risk Factors
The forward-looking statements contained under “Outlook for Fiscal 2015” in Part I, Item 2., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and all other statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” “projections,” and words of similar meaning, constitute forward-looking statements that involve a number of risks and uncertainties that are difficult to predict. Moreover, from time to time, we may issue other forward-looking statements. Forward-looking statements regarding financial performance in future periods, including the statements under “Outlook for Fiscal 2015,” do not reflect potential impacts of mergers or acquisitions or other significant transactions or events that have not been announced as of the time the statements are made. Actual outcomes and results may differ materially from what is expressed or forecast in forward-looking statements. We disclaim any obligation to update forward-looking statements to reflect future events or revised expectations. Our business faces many risks, and set forth below are some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors.
Weakness in the United States and international economies may harm our business.
Our revenue levels are generally dependent on the level of technology capital spending, which includes worldwide expenditures for electronic design automation (EDA) software, hardware, and consulting services. Periods of economic uncertainty, such as the 2008 worldwide recession, weakness in the European Union related to the debt crisis, and the continued weakness of the Japanese economy together with the consolidation and restructuring of numerous large Japanese electronics companies, can adversely affect our customers. In times of economic difficulty, customers may postpone decisions to license or purchase our products, reduce their spending, or be less able or willing to make payment obligations, any of which could adversely affect our business. In addition, significant customer payment defaults or bankruptcies could materially harm our business.
We are subject to the cyclical nature of the integrated circuit and electronics systems industries.
Purchases of our products and services are highly dependent upon new design projects initiated by customers in the integrated circuit (IC) and electronics systems industries. These industries are highly cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. The increasing complexity of ICs and resulting increase in costs to design and manufacture ICs have in recent years led to fewer design starts, which could cause a reduced demand for our products. In addition, the IC and electronics systems industries regularly experience significant downturns, often connected with, or in anticipation of, maturing product cycles within such companies or a decline in general economic conditions. These downturns could cause diminished demand for our products and services.
Our forecasts of our revenues and earnings outlook may be inaccurate.
Our revenues, particularly new hardware and software license revenues, are difficult to forecast. We use a “pipeline” system, a common industry practice, to forecast revenues and trends in our business. Sales personnel monitor the status of potential business and estimate when a customer will make a purchase decision, the dollar amount of the sale, and the products or services to be sold. These estimates are aggregated periodically to generate a sales pipeline. Our pipeline estimates may prove to be unreliable either in a particular quarter or over a longer period of time, in part because the “conversion rate” of the pipeline into contracts can be very difficult to estimate and requires management judgment. A variation in the conversion rate could cause us to plan or budget incorrectly and materially adversely impact our business or our planned results of operations. In particular, a slowdown in customer spending or weak economic conditions generally can reduce the conversion rate in a particular quarter as purchasing decisions are delayed, reduced in amount, or canceled. The conversion rate can also be affected by the tendency of some of our customers to wait until the end of a fiscal quarter attempting to obtain more favorable terms. This may result in failure to agree to terms within the fiscal quarter and cause expected revenue to slip into a subsequent quarter.
Our business could be impacted by fluctuations in quarterly results of operations due to customer seasonal purchasing patterns, the timing of significant orders, and the mix of licenses and products purchased by our customers.
We have experienced, and may continue to experience, varied quarterly operating results. Various factors affect our quarterly operating results and some of these are not within our control, including customer demand and the timing of significant orders. We typically experience seasonality in demand for our products, due to the purchasing cycles of our customers, with revenues in the fourth quarter generally being the highest. If planned contract renewals are delayed or the average size of renewed contracts is smaller than we anticipate, we could fail to meet our and investors’ expectations, which could have a material adverse impact on our stock price.
Our revenues are also affected by the mix of transaction types entered into where we recognize revenues in different ways as required by accounting rules: as payments become due and payable, on a cash basis, ratably over the license term, or at the beginning of the license term. A shift in the license mix toward increased ratable, due and payable, and/or cash-based revenue recognition could result in increased deferral of revenues to future periods and would decrease current revenues, which could result in us not meeting near-term revenue expectations.
The gross margin on our software is greater than that for our emulation hardware systems, software support, and professional services. Therefore, our gross margin may vary as a result of the mix of products and services sold. We also have a significant amount of fixed or relatively fixed costs, such as employee costs and purchased technology amortization, and costs which are committed in advance and can only be adjusted periodically. As a result, a small failure to reach planned revenues would likely have a relatively large negative effect on resulting earnings. If anticipated revenues do not materialize as expected, our gross margin and operating results could be materially adversely impacted.
We face intense price competition in the EDA industry.
Price competition in the EDA industry is intense, which can lead to, among other things, price reductions, longer selling cycles, lower product margins, loss of market share, and additional working capital requirements. If our competitors offer significant discounts on certain products, we may need to lower our prices or offer other favorable terms to compete successfully. Any such changes would likely reduce margins and could materially adversely impact our operating results. Any broad-based changes to our prices and pricing policies could cause new license and service revenues to decline or be delayed as the sales force implements and our customers adjust to the new pricing policies. Some of our competitors may bundle certain software or hardware products with other more desirable products at low prices or no marginal cost for promotional purposes, as a long-term pricing strategy, or to engage in predatory pricing. These practices could significantly reduce demand for our products or limit prices we can charge.
We currently compete primarily with two large companies: Synopsys, Inc. and Cadence Design Systems, Inc. We also compete with smaller companies with focused product portfolios and manufacturers of electronic devices and semiconductor equipment that have acquired or internally developed their own EDA products.
We may experience difficulty in manufacturing our emulation hardware.
We currently contract with one manufacturer to assemble our hardware emulation products and purchase some components from a single supplier. We may be exposed to delays in production and delivery of our emulation products due to delays in receiving components or manufacturing constraints; components rejected that do not meet our standards; components with latent defects; low yields of ICs, subassemblies, or printed circuit boards (PCBs); natural disasters such as weather or earthquakes; or other delays in the manufacturing process. For single source parts we purchase for our emulation products,
there can be no assurance that, if a supplier cannot deliver, a second source can be found on a timely basis. Our reliance on sole suppliers may also result in reduced control over product pricing and quality.
New conflict minerals regulations may cause us to incur additional expenses and may adversely impact our ability to conduct our business.
The Securities and Exchange Commission (SEC) has adopted disclosure rules for companies that use conflict minerals (commonly referred to as tantalum, tin, tungsten, and gold) in their products, with substantial supply chain verification requirements if the materials come from, or could have come from, the Democratic Republic of the Congo or adjoining countries. We have incurred and expect to continue to incur costs designing and implementing processes to discover the origin of the conflict minerals used in our hardware products. Implementing these requirements could affect the sourcing, availability and pricing of materials used in our hardware products as well as the companies we use to manufacture our products and their components. As a result, there may only be a limited pool of suppliers who provide conflict-free metals, and we cannot assure you that we will be able to obtain products in sufficient quantities or at competitive prices. The costs of complying with these laws could adversely affect our current or future business.
We may have to replace emulation components under warranty.
Our emulation hardware products are complex and despite pre-shipment testing, some defects may only appear after the products are put into use under operating conditions, including longer-term, continuous use at high capacities. As a result, customers may experience failures requiring us to replace components under warranty, thus increasing our costs and reducing availability of components for other sales.
Foreign currency fluctuations may have an adverse impact on our operating results.
We typically generate about half of our revenues from customers outside the United States (U.S.) and we generate approximately 40% of our expenses outside the U.S. While most of our international sales are denominated in U.S. dollars, our international operating expenses are typically denominated in foreign currencies. Significant changes in currency exchange rates, particularly in the Japanese yen, the euro, and the British pound, could have an adverse impact on our operating results.
Our international operations involve risks that could increase our expenses, adversely affect our operating results, and require increased time and attention of our management.
Our international operations subject us to risks in addition to those we face in our domestic operations, including longer receivables collection periods; issues relating to complying with complex customs regulations and paying customs duties and value added taxes; changes in a specific country’s or region’s economic or political conditions; trade protection measures; local labor laws; import or export licensing requirements; anti-corruption, anti-bribery, and other similar laws; loss or modification of exemptions for taxes and tariffs; limitations on repatriation of earnings; and difficulties with licensing and protecting our intellectual property (IP) rights. If we violate laws related to our business, we could be subject to penalties, fines, or other sanctions and could be prohibited or restricted from doing business in one or more countries.
IC and printed circuit board technology evolves rapidly.
The complexity of ICs, PCBs, and electrical systems continues to rapidly increase. In response to this increasing complexity, new design tools and methodologies must be invented or acquired quickly to remain competitive. If we fail to quickly respond to new technological developments, our products could become obsolete or uncompetitive, which could materially adversely impact our business.
Errors or defects in our products and services could expose us to liability.
Our customers use our products and services in designing and developing products that involve a high degree of technological complexity and have unique specifications. Due to the complexity of the systems and products with which we work, some of our products can be adequately tested only when put to full use in the marketplace. As a result, our customers or their end users may discover errors or defects in our software, or the products or systems designed with, or manufactured using our software that may not operate as expected. Errors or defects could result in:
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• | Loss of current customers, loss of market share, and loss of, or delay in, revenue; |
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• | Failure to attract new customers or achieve market acceptance; |
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• | Diversion of development resources to resolve problems resulting from errors or defects; |
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• | Disputes with customers relating to such errors or defects, which could result in litigation or other concessions; and |
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• | Increased support or service costs. |
In addition, we include limited amounts of third-party technology in our products and we rely on those third parties to provide support services to us. Failure of those third parties to provide necessary support services could materially adversely impact our business.
Long sales cycles and delay in customer completion of projects make the timing of our revenues difficult to predict.
We have a long sales cycle. A lengthy customer evaluation and approval process is generally required due to the complexity and expense associated with our products and services. Consequently, we may incur substantial expenses and devote significant management effort and expense to develop potential relationships that do not result in agreements or revenues and may prevent us from pursuing other opportunities. Sales of our products and services are sometimes discretionary and may be delayed if customers delay approval or commencement of projects due to budgetary constraints, internal acceptance review procedures, timing of budget cycles, or timing of competitive evaluation processes. Long sales cycles for our hardware products may subject us to risks over which we have limited control, including insufficient, excess, or obsolete inventory, variations in inventory valuation, and fluctuations in quarterly operating results.
Any loss of our leadership position in certain categories of the EDA market could harm our business.
The industry in which we compete is characterized by very strong leadership positions in specific categories of the EDA market. For example, one company may have a large percentage of sales in the physical verification category of the market while another may have a similarly strong position in mixed-signal simulation. These strong leadership positions can be maintained for significant periods of time as the software is difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from niche areas in which we are the leader. Conversely, it is difficult for us to achieve significant profits in niche areas where other companies are the leaders. If for any reason we lose our leadership position in an important niche, we could be materially adversely impacted.
Pre-announcing products may adversely impact current sales.
We or our competitors sometimes pre-announce or provide "road maps" of the expected availability of new hardware or software products or product features. Such pre-announcements, whether offered by the pre-announcing company or vendors of competitive products, can result in customers canceling or deferring orders for currently offered products as customers anticipate that currently offered products may be uncompetitive or lacking in features or performance. In the case of hardware products, slowing sales may cause inventories to increase or become obsolete and as a result the vendor may need to discount or reduce production of the current products.
We derive a substantial portion of our revenues from relatively few product groups.
We derive a substantial portion of our revenues from sales of relatively few product groups and related support services. As a result, any factor adversely affecting sales of these products, including the product release cycles, market acceptance, product competition, performance and reliability, reputation, price competition, and economic and market conditions, could harm our operating results.
Accounting rules governing revenue recognition are complex and may change.
The accounting rules governing revenue recognition are complex and have been subject to authoritative interpretations that have generally made it more difficult to recognize software revenues at the beginning of the license period. To the extent that we do not recognize as much revenue at the beginning of the license period as in the past, such a change in accounting rules could have a material adverse impact on our short-term results.
We may have additional tax liabilities.
Significant judgments and estimates are required in determining the provision for income taxes and other tax liabilities worldwide. Our tax expense may be impacted if our intercompany transactions, which are required to be computed on an arm’s-length basis, are challenged and successfully disputed by the tax authorities. Also, our tax expense could be impacted depending on the applicability of withholding taxes on software licenses and related intercompany transactions in certain jurisdictions. In determining the adequacy of income taxes, we assess the likelihood of adverse outcomes that could result if our tax positions were challenged by the Internal Revenue Service (IRS) and other local or foreign tax authorities. The tax authorities in the countries where we do business regularly examine our income and other tax returns. The ultimate outcome of these examinations cannot be predicted with certainty.
Forecasting our income tax rate is complex and subject to uncertainty.
The computation of income tax expense (benefit) is complex as it is based on the laws of numerous taxing jurisdictions and requires significant judgment on the application of complicated rules governing accounting for tax provisions under U.S. generally accepted accounting principles (GAAP). Income tax expense (benefit) for interim quarters is based on a forecast of our global tax rate, including a separate determination for entities, if any, with losses for which no tax benefit is obtained. This forecast includes forward looking financial projections, including the expectations of profit and loss by jurisdiction, and contains numerous assumptions. Various items cannot be accurately forecast and future events may be treated as discrete to the period in which they occur. Our income tax rate can be materially impacted, for example, by the geographical mix of our profits and losses; changes in our business, such as internal restructuring and acquisitions; changes in tax laws and accounting guidance, and other regulatory, legislative or judicial developments; tax audit determinations; changes in our tax positions; changes in our intent and capacity to permanently reinvest foreign earnings; changes to our transfer pricing practices; tax deductions attributed to equity compensation; and changes in our valuation allowance for deferred tax assets. For these reasons, our overall global tax rate may be materially different than our forecast.
Many of the countries where we are subject to taxes, such as the U.S. and numerous foreign jurisdictions, including France, Ireland, Israel, India and Japan, could have significant changes in their legislation and regulations concerning taxation. Additionally, certain tax policy efforts by the European Union and the Organisation for Economic Co-operation and Development could have a material effect on the taxation of international business and in particular, companies which publish software. Such changes, if brought into tax legislation, regulations and policy, could increase our effective tax rates in countries where we have significant operations and our overall tax rate could be materially affected, impacting our operating results, cash flows and financial condition.
There are limitations on the effectiveness of controls.
We do not expect that disclosure controls or internal control over financial reporting will prevent all errors and all fraud or that our policies and procedures can prevent all violations of the law by our employees, contractors, or agents. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that our control system will detect all errors and instances of fraud, if any or prevent our employees, contractors, or agents from breaching or circumventing our policies or violating laws and regulations. Failure of our control systems to prevent error and fraud or violations of the law could materially adversely impact us.
We are subject to changing corporate governance regulations that impact compliance costs and risks of noncompliance.
Rules and regulations set out by various governmental and self-regulatory organizations in the U.S. such as the SEC, NASDAQ, the Financial Industry Regulatory Authority, and the Financial Accounting Standards Board, as well as in other worldwide locations where we operate, are continually evolving in scope and complexity which makes compliance increasingly difficult and uncertain. The increase in costs to develop awareness and comply with such evolving rules and regulations as well as any risk of noncompliance could adversely impact us.
We may not realize revenues as a result of our investments in research and development.
We incur substantial expense to develop new software products. Research and development activities are often performed over long periods of time. These efforts may not result in a successful product offering because of changes in market conditions or our failure to successfully develop products based on that research and development activity. As a result, we could realize little or no revenues related to our investment in research and development.
We may acquire other companies and may not successfully integrate them.
We have acquired numerous businesses and have frequently been in discussions with potential acquisition candidates, and we may acquire other businesses in the future. While we generally analyze potential transactions before committing to them, we cannot assure that any completed transaction will result in long-term benefits to us or our shareholders or that we will be able to manage the acquired businesses effectively. In addition, growth through acquisition involves a number of risks. If any of the following events occurs after we acquire another business, it could materially adversely impact us:
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• | Difficulties in combining previously separate businesses into a single unit; |
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• | The substantial diversion of management’s attention from ongoing business when integrating the acquired business; |
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• | The failure to realize anticipated benefits, such as cost savings and increases in revenues; |
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• | The failure to retain key personnel of the acquired business; |
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• | Difficulties related to assimilating the products of an acquired business in, for example, distribution, engineering, and customer support areas; |
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• | Unanticipated liabilities or litigation in connection with or as a result of an acquisition, including claims from terminated employees, customers, or third parties; |
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• | Adverse impacts on existing relationships with suppliers and customers; and |
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• | Failure to understand and compete effectively in markets in which we have limited experience. |
Acquired businesses may not perform as projected, which could result in impairment of acquisition-related intangible assets. Additional challenges include integration of sales channels, training and education of the sales force for new product offerings, integration of product development efforts, integration of systems of internal controls, and integration of information systems. Accordingly, in any acquisition there will be uncertainty as to the achievement and timing of projected synergies, cost savings, and sales levels for acquired products. All of these factors could impair our ability to forecast, meet revenues and earnings targets, and effectively manage our business for long-term growth.
Our competitors may acquire technology or other companies that impact our business.
Our competitors may acquire technology or companies offering competing or complementary product offerings which could adversely impact our ability to compete in the marketplace. They may be able to deliver better or broader product offerings, offer better pricing, or otherwise make it more desirable for our customers to buy more of the tools in their design flow from the competitor after the acquisition. In addition, our competitors may purchase companies or technology that we had an interest in acquiring, which could limit our expansion into certain market segments.
Customers may acquire or merge with other customers or their business.
Like many industries, the semiconductor and electronics industries are subject to mergers, acquisitions, and divestitures and our customers or parts of their business may acquire or be acquired by other customers. Such synergies could result in fewer customers in the industries or the loss of some customers to competitors, or reduced customer spending on software and services due to redundancies or stronger customer negotiating power, which could have an adverse effect on our business and future revenues.
Customer payment defaults could adversely affect our timing of revenue recognition.
We use fixed-term license agreements as standard business practices with customers we believe are creditworthy. These multi-year, multi-element term license agreements have payments spread over the license term and are typically about three years in length for semiconductor companies and about four years in length for IC foundries and military and aerospace companies. The complexity of these agreements tends to increase the risk associated with collectibility from customers that can arise for a variety of reasons including ability to pay, product dissatisfaction, and disputes. If we are unable to collect under these agreements, our results of operations could be materially adversely impacted. We use these fixed-term license agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. If we no longer had a history of collecting without providing concessions on the terms of the agreements, then under U.S. GAAP, revenue would be required to be recognized as the payments become due and payable over the license term. This change could have a material adverse impact on our near-term results.
We may not adequately protect our proprietary rights or we may fail to obtain software or other intellectual property licenses.
Our success depends, in large part, upon our proprietary technology. We generally rely on patents, copyrights, trademarks, trade secret laws, licenses, and restrictive agreements to establish and protect our proprietary rights in technology and products. Despite precautions we take to protect our IP, we cannot assure that third parties will not try to challenge, invalidate, or circumvent these protections. The companies in the EDA industry, as well as entities and persons outside the industry, continue to obtain patents at a rapid rate. We cannot predict if any of these patents will cover any of our products. In addition, many of these entities have substantially larger patent portfolios than we have. As a result, we may on occasion be forced to engage in costly patent litigation to protect our rights or defend our customers’ rights. We may also need to settle these claims on terms that are unfavorable; such settlements could result in the payment of significant damages or royalties, or force us to stop selling or redesign one or more products. We cannot assure that the rights granted under our patents will provide us with any competitive advantage, that patents will be issued on any of our pending applications, or that future patents will be sufficiently broad to protect our technology. Furthermore, the laws of foreign countries may not protect our proprietary rights in those
countries to the same extent as U.S. law protects these rights in the U.S. In addition, despite our measures to limit piracy, other parties may attempt to illegally copy or use our products, which could result in lost revenue.
Some of our products include software or other IP licensed from third parties, and we may have to seek new licenses or renew existing licenses for software and other IP in the future. Failure to obtain software or other IP licenses or rights from third parties on favorable terms could materially adversely impact us.
Intellectual property infringement actions may harm our business.
Patent holders are making increasing efforts to monetize their patent portfolios. IP infringement claims against us directly, or where we contractually must defend our customers, could result in costly litigation and consume significant time of employees and management. In addition, IP litigation could harm our business, either due to damage awards, payment of legal fees, an obligation to refund license fees to a customer or forgo receipt of future customer payments, the need to license technology on what might be unfavorable business terms, injunctions that could stop or delay future shipments, or the need to redesign our technology. For example, we are currently engaged in patent infringement litigation in Japan, California, and Oregon involving Emulation and Verification Engineering S.A., EVE-USA, Inc., and Synopsys, Inc. Further information regarding these lawsuits is contained in Part II, Item 1. "Legal Proceedings".
Our use of open source software could negatively impact our ability to sell our products and may subject us to unanticipated obligations.
The products, services or technologies we acquire, license, provide or develop may incorporate or use open source software. We monitor and restrict our use of open source software in an effort to avoid unintended consequences, such as reciprocal license grants, patent retaliation clauses, and the requirement to license our products at no cost. Nevertheless, we may be subject to unanticipated obligations regarding our products which incorporate open source software.
Our failure to attract and retain key employees may harm us.
We depend on the efforts and abilities of our senior management, our research and development staff, and a number of other key management, sales, support, technical, and services personnel. Competition for experienced, high-quality personnel is intense, and we cannot assure that we can continue to recruit and retain such personnel. Our failure to hire and retain such personnel could impair our ability to develop new products and manage our business effectively.
We have global sales and research and development offices in parts of the world that are not as politically stable as the United States.
We have global sales and research and development offices, some of which are in parts of the world that are not as politically stable as the U.S. In particular, approximately 14% of our workforce, and a larger percentage of our engineers, are located in our offices in Israel, Egypt, Pakistan, Armenia, and Russia and may be subject to disruption or closure from time to time. As a result, we may face a greater risk of business interruption as a result of potential unrest, terrorist acts, or military conflicts than businesses located domestically. This could have a material and adverse effect on product delivery and our research and development operations.
Our business is subject to the risk of natural disasters.
We have sales and research and development offices worldwide which may be adversely affected by weather, earthquakes, or other natural disasters. If a natural disaster occurs at or near any of our offices, our operations may be interrupted, which could adversely impact our business and results of operations. In addition, if a natural disaster impacts a significant number of our customers, our business and results of operations could be adversely impacted.
If our information technology security measures are breached, our information systems may be perceived as being insecure, which could harm our business and reputation.
Our products and services involve the storage and transmission of proprietary information owned by us and our customers. We have sales and research and development offices throughout the world. Our operations are dependent upon the connectivity of our operations worldwide. Despite our security measures, our information technology and infrastructure may be vulnerable to cyber-attacks or breached due to employee errors or other disruptions that could result in unauthorized disclosure of sensitive information and could significantly interfere with our business operations. Breaches of our security measures could expose us to a risk of loss or misuse of this information, adverse publicity, violations of privacy laws, and litigation. Because techniques used to obtain unauthorized access or to sabotage information systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. In addition, with the use of "cloud" services in our business, despite our attempts to validate the security of such services,
proprietary information may be misappropriated by third parties. If there is an actual or perceived breach of our security, or the security of one of our vendors, the market perception of the effectiveness of our security measures could be harmed and we could suffer damage to our reputation or our business, or lose existing customers and lose our ability to obtain new customers.
Our shareholder rights plan may have anti-takeover effects.
In June 2013, we extended the term of our shareholder rights plan for 24 months, which has the effect of making it more difficult for a person to acquire control of us in a transaction not approved by our board of directors. The provisions of our shareholder rights plan could have the effect of delaying, deferring, or preventing a change of control of us, could discourage bids for our common stock at a premium over the market price of our common stock and could materially adversely impact the market price of, and the voting and other rights of the holders of, our common stock.
Our revolving credit facility has financial and non-financial covenants, and default of any covenant could materially adversely impact us.
Our bank revolving credit facility imposes operating restrictions on us in the form of financial and non-financial covenants. Financial covenants include adjusted quick ratio, tangible net worth, leverage ratio, senior leverage ratio, and minimum cash and accounts receivable ratio. If we were to fail to comply with the financial covenants and did not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility. The declaration of an event of default could have a material adverse effect on our financial condition. We could also find it difficult to obtain other bank lines or credit facilities on comparable terms.
We have a substantial level of indebtedness.
As of July 31, 2014, we had $257 million of outstanding indebtedness, which includes principal of $253 million of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures) and $4 million in short-term borrowings. This level of indebtedness among other things could:
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• | Make it difficult for us to satisfy our payment obligations on our debt; |
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• | Make it difficult for us to incur additional indebtedness or obtain any necessary financing in the future for working capital, capital expenditures, debt service, acquisitions, or general corporate purposes; |
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• | Limit our flexibility in planning for or reacting to changes in our business; |
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• | Reduce funds available for use in our operations; |
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• | Make us more vulnerable in the event of a downturn in our business; and |
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• | Place us at a possible competitive disadvantage relative to less leveraged competitors and competitors that have greater access to capital resources. |
We may also be unable to borrow funds as a result of an inability of financial institutions to lend due to restrictive lending policies and/or institutional liquidity concerns.
Our 4.00% Debentures are convertible under certain circumstances at a conversion price as of July 31, 2014 of $20.26 per share (as adjusted for the effect of cash dividends and other applicable items). These circumstances include the market price of our common stock exceeding 120% of the conversion price, or $24.31 per share as of July 31, 2014, for at least 20 of the last 30 trading days of the previous fiscal quarter. If our 4.00% Debentures become convertible and any of the holders elect to convert their debentures, we would be required to pay cash for at least the principal amount of any converted debentures and cash or shares for the excess of the value of the converted shares over the principal amount. At this time, we believe it is unlikely that the holders of a significant amount of our 4.00% Debentures would elect to convert, since the current market price of the 4.00% Debentures substantially exceeds the conversion value.
If we experience a decline in revenues, we could have difficulty paying amounts due on our indebtedness. Any default under our indebtedness could have a material adverse impact on our business, operating results, and financial condition.
Our stock price could become more volatile, and your investment could lose value.
All of the factors discussed in this “Risk Factors” section could affect our stock price. The timing of announcements in the public market regarding new products, product enhancements, or technological advances by our competitors or us, and any announcements by us or by our competitors of acquisitions, major transactions, or management changes could also affect our stock price. Our stock price is subject to speculation in the press and the analyst community, changes in recommendations or earnings estimates by financial analysts, changes in investors’ or analysts’ valuation measures for our stock, our credit ratings, and market trends unrelated to our performance. A significant drop in our stock price could also expose us to the risk of
securities class actions lawsuits, which could result in substantial costs and divert management’s attention and resources, which could adversely affect our business.
Our business could be negatively affected as a result of actions of activist shareholders.
Responding to actions by activist shareholders can be costly and time-consuming, disrupting our operations, and diverting the attention of management and our employees. The perceived uncertainties as to our future direction may result in the loss of potential business opportunities, and may make it more difficult to attract and retain qualified personnel and business partners.
Ability to pay dividends.
We currently declare and pay quarterly cash dividends on our common stock. Any future payment of cash dividends will depend upon our financial condition, earnings, available cash, cash flow, and other factors our board of directors deems relevant. Our revolving credit facility contains certain financial and other covenants, including a limit on the aggregate amount we can pay for dividends and repurchases of our stock over the term of the facility of $50,000 plus 70% of our cumulative net income for the periods after January 31, 2011. We were in compliance with all financial covenants as of July 31, 2014. If we fail to comply with the financial covenants and are unable to obtain a waiver from our lenders, we would be in default under the revolving credit facility and our board could decide to reduce or eliminate our current dividend. In addition, our board may decrease or discontinue payment of dividends at any time, which could cause the market price of our stock to decline.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
The table below sets forth information regarding repurchases of our common stock by us during the three months ended July 31, 2014:
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Period | Total number of shares purchased | | Average price paid per share | | Total number of shares purchased as part of publicly announced programs | | Maximum dollar value of shares that may yet be purchased under the programs |
May 1 - May 31, 2014 | — |
| | $ | — |
| | — |
| | $ | — |
|
June 1 - June 30, 2014 | 485,000 |
| | $ | 21.44 |
| | 485,000 |
| | $ | 189,601,889 |
|
July 1 - July 31, 2014 | 674,055 |
| | $ | 21.66 |
| | 674,055 |
| | $ | 175,000,019 |
|
| 1,159,055 |
| | $ | 21.57 |
| | 1,159,055 |
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In April 2014 our previous three-year share repurchase program expired. On June 12, 2014, we announced a new share repurchase program approved by our Board of Directors, authorizing the repurchase of up to $200 million of our common stock over a three-year period.
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3.A | | 1987 Restated Articles of Incorporation, as amended. |
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10.A | | 2010 Omnibus Incentive Plan, as amended. |
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10.B | | Form of Restricted Stock Unit Award Agreement for grants of restricted stock units to non-employee directors under our 2010 Omnibus Incentive Plan. |
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31.1 | | Certification of Chief Executive Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 | | Certification of Chief Financial Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32 | | Certifications of Chief Executive Officer and Chief Financial Officer of Registrant Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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101.INS | | XBRL Instance Document |
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101.SCH | | XBRL Taxonomy Extension Schema Document |
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101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document |
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101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document |
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101.LAB | | XBRL Taxonomy Extension Label Linkbase Document |
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101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
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.
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| Dated: September 4, 2014 | | MENTOR GRAPHICS CORPORATION (Registrant) |
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| | | /S/ GREGORY K. HINCKLEY |
| | | Gregory K. Hinckley |
| | | President, Chief Financial Officer |