10-K 1 ment-2014131x10k.htm 10-K MENT - 2014.1.31 - 10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________
Form 10-K
_________________________________________
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED January 31, 2014
COMMISSION FILE NUMBER 1 – 34795
________________________________________

MENTOR GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)
_________________________________________
Oregon
 
93-0786033
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
8005 SW Boeckman Road
Wilsonville, Oregon
 
97070-7777
(Address of principal executive offices)
 
(Zip Code)
(503) 685-7000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: 
Title of Each Class
 
Name of Each Exchange on which Registered
Common Stock, without par value
 
NASDAQ Global Select Market
Incentive Stock Purchase Rights
 
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes   x     No   ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes   ¨     No   x
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 (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 twelve 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K.  x
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
x
Accelerated Filer
¨
 
 
 
 
Non-accelerated filer
o  (Do not check if a smaller reporting company)
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
The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $2,313,193,631 on July 31, 2013 based upon the last price of the Common Stock on that date reported in The NASDAQ Global Select Market. On March 13, 2014, there were 115,360,422 shares of the Registrant’s Common Stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Document
 
Part of Form 10-K into which incorporated
Portions of the 2014 Proxy Statement
 
Part III



Mentor Graphics Corporation
Annual Report on Form 10-K
Year to date January 31, 2014

Table of Contents
 
 
 
 
 
 
Page
 
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
Item 15.
 

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Part I
 
Item 1.    Business
This Form 10-K contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those set forth under Part I, Item 1A. “Risk Factors.”
GENERAL
Mentor Graphics Corporation is a technology leader in electronic design automation (EDA). We provide software and hardware design solutions that enable our customers to develop better electronic products faster and more cost effectively. We market our products and services worldwide, primarily to large companies in the communications, computer, consumer electronics, semiconductor, networking, multimedia, military and aerospace, and transportation industries.
The electronic components and systems that our customers create with our products include integrated circuits (ICs), printed circuit boards (PCBs), field programmable gate arrays (FPGAs), embedded software solutions, wire harness systems, and computers. Our products are used in the design and development of a diverse set of electronic products, including automotive electronics, computers and workstations, digital cameras, cellular telephones, medical devices, smart phones, industrial electronics, and manufacturing systems. As silicon manufacturing process geometries shrink, our customers are creating entire electronic systems on a single IC. These devices are called a system-on-chip (SoC). This trend becomes apparent to the everyday consumer as consumer electronics become smaller and more sophisticated. This trend also poses significant opportunities and challenges for the EDA industry.
We were incorporated in Oregon in 1981, and our common stock is traded on The NASDAQ Global Select Market under the symbol “MENT.” Our corporate headquarters are located at 8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777. The telephone number at that address is (503) 685-7000. Our website address is www.mentor.com. We have approximately 75 offices worldwide. Electronic copies of our reports filed with the Securities and Exchange Commission (SEC) are available through our website as soon as reasonably practicable after the reports are filed with the SEC. Our Director Code of Ethics, Standards of Business Conduct, Guidelines for Corporate Disclosure, Corporate Governance Guidelines, and our Audit, Compensation, and Nominating and Corporate Governance Committee Charters are also posted on our website.
PRODUCTS
We design our products to enable engineers to overcome increasingly complex electronic design challenges by improving the accuracy of complex designs and shrinking product time-to-market schedules. A hardware design process is typically as follows:
Electrical engineers begin the design process by describing and specifying the architectural, behavioral, functional, and structural characteristics of an IC, PCB, or electronic system and components.
Engineers then create the component designs according to stated specifications.
Engineers verify the design to reveal defects and then modify the component’s design until it is correct and meets the previously stated specifications.
Engineers assemble components and test the components and the entire system.
The system then goes to production. During the manufacturing process, engineers work to identify defective parts and improve yields. “Yields” refers to the percentage of functional ICs on a silicon wafer or functional PCBs compared to the total of those manufactured.
We segregate revenues into five categories of similar products and services. These categories include Scalable Verification, IC Design to Silicon, Integrated System Design, New and Emerging Products, and Services and Other. Each category includes both product and support revenues. Additional information is provided in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Scalable Verification
The Mentor Graphics® Scalable Verification™ tools allow engineers to verify that their complex IC designs function as intended. Functional errors are a leading cause of design revisions that slow down an electronic system’s time-to-market and reduce its profitability.

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The Questa® scalable verification platform includes support for hardware description languages, including System Verilog, simulation, and new methodologies including assertions, use of verification intellectual property (IP), test benches, and formal verification methods. The Questa platform is used for verification of systems and ICs including application-specific integrated circuits, SoCs, and FPGAs.
Along with digital simulation products, we offer analog/mixed-signal simulators. Complex electronic designs often require different types of circuits, such as analog and digital, to work together. An example is a CD or DVD player which uses a digital input and produces an analog output of sounds or images. Our analog/mixed signal simulation products include the Eldo®, ADVance MS, and ADiT™ tools.
We provide hardware emulation systems, such as our Veloce® product family, which allow users to create high-performance functional and logical equivalent models of actual electronic circuits to verify the function and timing of those circuits. Hardware emulation systems typically run complex electronic circuits 100 times to 1,000 times faster than software simulation tools. Emulation is also used when software operating systems are embedded within circuits and there is a need for hardware/software verification and debugging. Our Veloce product allows customers to verify complex designs containing up to two billion logic gates.
IC Design to Silicon
Shrinking geometries and increasing design size in the nanometer era have enabled ever increasing functionality on a single IC. Today’s most advanced ICs are being produced in a 20 nanometer (nm) process with ongoing test tape-outs occurring for 14 nm ICs and prototype work at 10 nm and below. Nanometer process geometries cause design challenges in the creation of ICs which are not present at larger geometries. As a result, nanometer process technologies, used to deliver the majority of today’s ICs, are the product of careful design and precision manufacturing. The increasing complexity and smaller size of designs have changed how those responsible for the physical layout of an IC design deliver their design to the IC manufacturer or foundry. In older technologies, this handoff was a relatively simple layout database check when the design went to manufacturing. Now it is a multi-step process where the layout database is checked and modified so the design can be manufactured with cost-effective yields of ICs.
To address these challenges, we offer the Calibre® tool family, which is a standard for most of the world’s largest integrated device manufacturers and foundries:
The Calibre physical verification tool suite, Calibre DRC™ and Calibre LVS-H™, helps ensure that a particular IC layout accurately corresponds to the original schematic or circuit diagram of the design and conforms to stringent manufacturing rules at wafer fabricators where ICs are manufactured.
The Calibre xRC™ and xACT products, transistor-level extraction and device modeling tools, compute the values of detailed circuit parameters including interconnect resistances, capacitances, and inductances to enable customers to more accurately simulate the performance of a design before it is manufactured.
The Calibre Resolution Enhancement Technology (RET) tools allow wafer foundries to simulate the lithographic patterning system and apply modifications to the design layout patterns to overcome the resolution limits of the physical wafer patterning process. The Calibre family of optical proximity correction (OPC), RET, and mask data preparation tools enable higher yields in semiconductor manufacturing. The Calibre OPCverify™ tool is used to check and report the effectiveness of mask pattern corrections against wafer manufacturing specifications. The Calibre RET tools continue to be extended to provide computational patterning capabilities for process technology nodes from .13 micron to 7 nanometers.
In the Design For Manufacturing (DFM) area, the Calibre LFD™ product can help customers produce higher yields at nanometer process geometries where variations in manufacturing can cause yield reductions. The Calibre CMPAnalyzer tool allows customers to model the expected planarity (i.e., thickness variation) of ICs and identify where modifications to the layout will improve a chip’s flatness. This helps prevent manufacturing defects and reduces variations in performance from one chip to the next. The Calibre MPCpro™ product is a solution for systematic errors introduced by e-beam lithography and mask etching processes built on Calibre OPCpro™ technology for optical process correction. Our Calibre nmMPC™ product provides optimizations specifically developed for e-beam mask writers. New correction and modeling capabilities improve mask linearity and uniformity for advanced nodes, especially for smaller feature sizes.
The Calibre PERC™ tool checks the electrical design of an IC. It is useful in verifying the completeness of electrostatic discharge protection circuitry which affects both manufacturing yield and long-term reliability of an IC.
We also offer the Olympus-SoC™ place and route product targeted at customers designing ICs at advanced nodes. The Olympus-SoC system comprehensively addresses the performance, capacity, time-to-market, power, and variability challenges

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encountered at the leading-edge process geometries. The Olympus-SoC place and route solution is a physical design implementation tool which performs design planning, placement, physical synthesis, clock tree synthesis, routing, power optimization, and manufacturability closure. The Olympus-SoC tool is architected to handle the complex multi-patterning and FinFET requirements at advanced process technologies. The Calibre InRoute™ design and verification platform enables designers to increase their productivity by invoking Calibre tools within the Olympus-SoC place and route environment.
In December 2013, we acquired the RealTime synthesis tool to bring register-transfer level (RTL) synthesis to our digital implementation flow.  The RealTime solution helps SoC and application specific integrated circuit (ASIC) design teams to realize improved quality of results and faster turnaround time for complex SoCs, ASICs, and IP blocks. The RealTime tool’s “placement first” synthesis methodology and integrated RTL floorplanning capability enable physical backend issues to be analyzed and addressed at RTL stages before hand-off to the back-end groups for physical design implementation.
Our Tessent® suite of integrated silicon test products are used to test a design's logic and memories after manufacturing to ensure that a manufactured IC is functioning correctly. Our suite of tools includes scan insertion, boundary scan, automatic test pattern generation, logic and memory built-in self-test, and our patented Tessent TestKompress® product for EDT™. A suite of test analysis products is also available that leverages test data and layout-aware diagnosis capabilities for silicon debug and yield analysis.
Integrated System Design
As ICs grow in complexity and function and PCB fabrication technology advances to include embedded components and high-density interconnect layers within the PCB, the design of PCBs is becoming increasingly complex. This complexity can be a source of design bottlenecks.
Our PCB-FPGA Systems Design software products support the PCB design process from schematic entry, where the electronic circuit is defined by engineers, through physical layout of the PCB, and provide digital output data for manufacturing, assembly, and test. Most types of designs, including analog, radio frequency, and high-speed digital and mixed signal, are supported by our PCB design tools. We have specific integrated software tool flows for process management, component library creation, simulation, and verification of the PCB design:
The Xpedition™ Series product line is our principal PCB design family of products used by larger enterprise customers for PCB design flows from system design definition to manufacturing execution.
Our HyperLynx® product line offers a complete suite of analysis and verification software that meets the needs of PCB engineers at any point in the board design flow including tools for power integrity, thermal analysis, electromagnetic design/verification, analog simulation, and package modeling.
We also offer the “ready to use” PADS® product line which provides a lower cost Windows-based PCB design and layout solution.
Our I/O Designer™ product integrates FPGA input/output planning with our PCB design tools to help improve routing in large complex designs.
The XtremePCB™ tool offers a method for simultaneous design where multiple designers can edit the same design at the same time and view each other’s edits in real-time.
Our XtremeAR product is a PCB routing product that improves the routing time of large designs. This product allows improved designs by running more simultaneous routing iterations during the design cycle.
Our AutoActive place and route technology is available on both UNIX and Windows platforms and is used to replace older generation routers in PCB design flows. The AutoActive technology, which is incorporated into the Expedition® product line, is intended to help improve design quality, shorten design cycles, and increase manufacturability.
Our Valor® Division offers a line of products for PCB, DFM, and manufacturing execution systems. Valor’s solutions target three key segments in the PCB manufacturing market: design of the physical layout of the PCB, fabrication of the bare PCB, and assembly of PCB components.
Our Mechanical Analysis Division provides simulation software and consultancy services to reduce costs, eliminate design mistakes, and accelerate and optimize designs involving heat transfer and fluid flow before physical prototypes are built. Our FloEFD product is a 3D computational fluid dynamics and heat transfer analysis tool that is embedded into Mechanical Computer-Aided Design systems to help design engineers conduct computational fluid dynamics analysis throughout the product’s life cycle. Our FloTHERM® three-dimensional computational fluid dynamics software predicts airflow and heat transfer in and around electronic equipment, including effects of conduction, convection, and radiation to enable engineers to create virtual models of electronic equipment, perform thermal analysis, and test design modifications before any physical

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prototypes are built. This product line also includes one-dimensional computational fluid dynamics analysis. The Flowmaster® one-dimensional computational fluid dynamics analysis software is used by thermo-fluid system engineers to model and analyze the fluid mechanics and pipe flow in complex systems. In addition, the MicReD® T3Ster® advanced transient temperature measurement system enables thermal testing and characterization of electronics components, PCBs, and sub-systems.
New and Emerging Products
We provide specialized software tools for design, analysis, and documentation of the complex electrical systems found in automotive, aerospace, and other transportation platforms. The tools also support design, costing, and manufacturing process modeling of wire harnesses.
Our Embedded Systems Division provides runtime software, tools, and professional engineering services that enable our customers to build secure embedded systems utilizing heterogeneous multi-core and multi-OS platforms. We have focused initiatives in the automotive market segment where we provide LINUX and Android based infotainment solutions, as well as AUTOSAR networking solutions. In addition to the automotive market, our embedded software solutions are used in mobile, medical, aerospace, industrial, and consumer electronics markets, and deployed on over 3 billion devices.
PLATFORMS
Our software products are available on UNIX, Windows, and LINUX platforms in a broad range of price and performance levels. Customers purchase platforms from leading workstation and personal computer suppliers.
MARKETING AND CUSTOMERS
Our sales and marketing emphasizes large corporate account penetration in the communications, computer, consumer electronics, semiconductor, networking, multimedia, military and aerospace, and transportation industries. We license our products worldwide through our direct sales force, distributors, and sales representatives. Revenues outside of North America accounted for 56% of total revenues for fiscal 2014 and 2013 and 59% for fiscal 2012. We enter into foreign currency exchange contracts in an effort to mitigate the impact of foreign currency fluctuations. See “Geographic Revenues Information” in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the footnotes to our financial statements included in Part II, Item 8. “Financial Statements and Supplementary Data” for more information.
Over time, no material portion of our business is dependent on a single or a few customers. We do not believe that the competitive loss of one or more individual products at one or more of our customers would have a material adverse effect on our revenues. We have traditionally experienced some seasonal fluctuations of orders, with orders typically stronger in the fourth quarter of each year. Due to the complexity of our products, the selling cycle can be six months or longer. During the selling cycle our account managers, application engineers, and technical specialists make technical presentations and product demonstrations to the customer. At some point during the selling cycle, our products may also be loaned to customers for short-term on-site evaluation. We ship our software products to customers primarily electronically, and all software products are generally shipped within 180 days after receipt of an order and a substantial portion of quarterly shipments tend to be made in the last month of each quarter. We license our products and some third-party products pursuant to end-user license agreements.
BACKLOG
Our backlog of firm orders was approximately $161 million as of January 31, 2014 compared to $109 million as of January 31, 2013. This backlog includes software products requested for delivery within six months and emulation hardware systems, professional services, and training requested for delivery within one year. We do not track backlog for support services. The January 31, 2014 backlog of orders is expected to be delivered before the end of our fiscal year ending January 31, 2015.
MANUFACTURING OPERATIONS
Our software manufacturing operations primarily consist of reproduction of our technical software and documentation. Mentor Graphics (Ireland) Limited, our wholly owned subsidiary, manufactures, or contracts with third-parties to manufacture our products and distributes these products worldwide through our established sales channels. Our line of emulation products, which has a large hardware component, is manufactured principally in the United States (U.S.) on an outsourced basis. See the discussion in Note 17. “Segment Reporting” in Part II, Item 8. “Financial Statements and Supplementary Data” for further detail of the location of property, plant, and equipment.
PRODUCT DEVELOPMENT

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Our research and development is focused on continued improvement of our existing products and the development of new products. During the year ended January 31, 2014, we expensed $349 million related to product research and development compared to $314 million for fiscal 2013 and $311 million for fiscal 2012. We also seek to expand existing product offerings and pursue new lines of business through acquisitions. During the year ended January 31, 2014, we amortized purchased technology of $4 million compared to $8 million for fiscal 2013 and $10 million for fiscal 2012. Our future success depends on our ability to develop or acquire competitive new products that satisfy customer requirements.
CUSTOMER SUPPORT AND CONSULTING SERVICES
We have a worldwide support organization to meet our customers’ needs for technical support, training, and optimization services. Most of our customers enter into support contracts that deliver regular software updates with the latest improvements, technical assistance from experienced experts, access to a self-service support site, and participation in our interactive communities. Hardware support is available for emulation products. Mentor Graphics Education Services offers a range of learning solutions developed specifically for electronics designers and engineers.
Mentor Consulting, our professional services division, is comprised of a worldwide team of consulting professionals. The services provided to customers are concentrated around our products. In addition, Mentor Consulting provides methodology development and refinement services that help customers improve their product development processes.
COMPETITION
The markets for our products are characterized by price competition, rapid technological advances in application software, and new market entrants. The EDA industry tends to be labor intensive rather than capital intensive. This means that the number of actual and potential competitors is significant. While our two principal competitors are large companies with extensive capital and marketing resources, we also compete with small companies with little capital but innovative ideas. Our principal competitors are Cadence Design Systems, Inc. (Cadence) and Synopsys, Inc. (Synopsys).
We believe the main competitive factors affecting our business are breadth and quality of application software, product integration, ability to respond to technological change, quality of a company’s sales force, price, size of the installed base, level of customer support, and professional services. We can give no assurance, however, that we will have financial resources, marketing, distribution and service capability, depth of key personnel, or technological knowledge to compete successfully in our markets.
EMPLOYEES
We employed approximately 5,220 people full time as of January 31, 2014. Our future success will depend in part on our ability to attract and retain employees. None of our U.S. employees are covered by collective bargaining agreements. Employees in some jurisdictions outside the U.S. are represented by local or national union organizations. We continue to have satisfactory employee relations.
PATENTS AND LICENSES
We regard our products as proprietary and protect our rights in our products and technology in a variety of ways. We currently hold over 1,000 patents on inventions embodied in our products or that are otherwise relevant to EDA technology. In addition, we have approximately 350 patent applications pending in the U.S. and abroad. While we believe the patent applications relate to patentable technology, we cannot predict whether any patent will issue on a pending application, nor can we assure that any patent can be successfully defended.
We also rely on contractual and technical safeguards to protect our proprietary rights in our products. We typically include restrictions on disclosure, use, and transferability in our license agreements with customers and other parties. In addition, we use our trademark, copyright, and trade secret rights to protect our interests in our products and technology.
Some of our products include software or other intellectual property licensed from other parties. We also license software from other parties for internal use. We may have to seek new licenses or renew these licenses in the future.
 
Item 1A.Risk Factors
The forward-looking statements contained under “Outlook for Fiscal 2015” in Part II, Item 7. “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

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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 software, hardware, and consulting services. Periods of economic uncertainty, such as the recent worldwide recession, weakness in the European Union following 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 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.

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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 that have developed their own EDA products internally.
We may experience difficulty in manufacturing our emulation hardware.
We currently use 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; 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.
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 U.S. and we generate approximately one-third 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; 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 rights. If we violate laws related to our business, we could be subject to penalties, fines, or other sanctions and could be prohibited or limited 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

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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:
Loss of current customers, loss of market share, and loss of, or delay in, revenue;
Failure to attract new customers or achieve market acceptance;
Diversion of development resources to resolve problems resulting from errors or defects;
Disputes with customers relating to such errors or defects, which could result in litigation or other concessions; and
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.
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 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.
We may have additional tax liabilities.

10


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 tax authorities. The tax authorities in the U.S. and other countries where we do business regularly examine our income and other tax returns. The ultimate outcome of these examinations cannot be predicted with certainty. Should the IRS or other tax authorities assess additional taxes as a result of examinations, we may be required to record charges to operations that could have a material impact on the results of operations, financial position, or cash flows.
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. 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.
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 United States such as Securities and Exchange Commission, 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 expect to analyze all 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:

11


Difficulties in combining previously separate businesses into a single unit;
The substantial diversion of management’s attention from ongoing business when integrating the acquired business;
The failure to realize anticipated benefits, such as cost savings and increases in revenues;
The failure to retain key personnel of the acquired business;
Difficulties related to assimilating the products of an acquired business in, for example, distribution, engineering, and customer support areas;
Unanticipated costs;
Unanticipated liabilities or litigation in connection with or as a result of an acquisition, including claims from terminated employees, customers, or third parties;
Adverse impacts on existing relationships with suppliers and customers; and
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. generally accepted accounting principles, 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 intellectual property, 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

12


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 intellectual property licensed from third parties, and we may have to seek new licenses or renew existing licenses for software and other intellectual property in the future. Failure to obtain software or other intellectual property 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. Intellectual property 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. Further information regarding these lawsuits is contained in Part I, Item 3. "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 United States. In particular, approximately 10% of our workforce, and a larger percentage of our engineers, are located in our offices in Israel, Egypt, and Pakistan 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

13


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 January 31, 2014, we had $263 million of outstanding indebtedness, which includes principal of $253 million of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures) and $10 million in short-term borrowings. This level of indebtedness among other things could:
Make it difficult for us to satisfy our payment obligations on our debt;
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;
Limit our flexibility in planning for or reacting to changes in our business;
Reduce funds available for use in our operations;
Make us more vulnerable in the event of a downturn in our business; and
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 January 31, 2014 of $20.35 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 $24.42 per share as of January 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. If holders of a significant amount of our 4.00% Debentures elect to convert, we could have difficulty paying the amount due upon conversion, which would have material adverse impact on our liquidity and financial condition.
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.

14


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 board may decrease or discontinue payment of dividends at any time, which could cause the market price of our stock to decline.


15


Item 1B.Unresolved Staff Comments
None.
 
Item 2.
Properties
We own six buildings on 43 acres of land in Wilsonville, Oregon, occupying approximately 379,000 square feet in those buildings as our corporate headquarters. We also own an additional 69 acres of undeveloped land adjacent to our headquarters. Most administrative functions and a significant amount of our domestic research and development operations are located at the Wilsonville site. We own three buildings totaling approximately 196,000 square feet in Fremont, California which house research and development, sales, and administrative staff. We own two buildings totaling approximately 48,000 square feet in Shannon, Ireland which house information technology and administrative staff.
We lease additional space in Longmont, Colorado; Redmond, Washington; Huntsville and Mobile, Alabama; and Marlboro and Waltham, Massachusetts where some of our domestic research and development takes place; and in various locations throughout the United States and in other countries, primarily for sales and customer service operations. Additional research and development is done in locations outside the United States including locations in Armenia, Egypt, France, Germany, Hungary, India, Israel, Pakistan, Poland, Russia, Taiwan, and the United Kingdom. We believe that we will be able to renew or replace our existing leases as they expire and that our current facilities will be adequate through at least the year ending January 31, 2015.
 
Item 3.
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 intellectual property 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 filed a lawsuit claiming patent infringement against us in federal district court in the North 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. These cases seek compensatory damages and a permanent injunction against the licensing of several of our software and hardware products relating to our emulation and field programmable gate arrays synthesis products. 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 lawsuits, which allege that EVE’s Zebu emulation products infringe several of our patents, were filed against EVE in federal district court in Oregon. We also filed a patent lawsuit against EVE in Tokyo district court. Our litigation in Oregon and Japan seeks compensatory damages and an injunction against the sale of EVE emulation products. 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 4.
Mine Safety Disclosures
Not applicable.

16


EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the executive officers of Mentor Graphics Corporation:
 
Name
Position
Age

Walden C. Rhines
Chairman of the Board and Chief Executive Officer
67

Gregory K. Hinckley
President, Chief Financial Officer, and Director
67

L. Don Maulsby
Senior Vice President, World Trade
62

Brian Derrick
Vice President, Corporate Marketing
50

Richard P. Trebing
Corporate Controller and Chief Accounting Officer
58

Dean Freed
Vice President, General Counsel, and Secretary
55

Mike Vishny
Vice President, Chief Human Resources Officer
49

The executive officers are elected by our Board of Directors annually. Officers hold their positions until they resign, are terminated, or their successors are elected. There are no arrangements or understandings between the officers or any other person pursuant to which officers were elected. There are no family relationships among any of our executive officers or directors.
Dr. Rhines has served as our Chairman of the Board and Chief Executive Officer since 2000. Dr. Rhines served as our Director, President, and Chief Executive Officer from 1993 to 2000. Dr. Rhines is currently a director of Triquint Semiconductor, Inc., a semiconductor manufacturer, and served as director of Cirrus Logic, Inc., also a semiconductor manufacturer, from 1995 to 2009.
Mr. Hinckley has served as our President, Chief Operating Officer, and Director since 2000. Mr. Hinckley has served as our Chief Financial Officer since 2008. He has primary responsibility for the operations of our corporate centers, sales, and research and development divisions. Mr. Hinckley is a director of Super Micro Computer, Inc., a server board, chassis, and server systems supplier and SI Bone, Inc., a privately held medical device company. Until 2013, Mr. Hinckley was a director of Intermec, Inc., a provider of integrated systems solutions.
Mr. Maulsby has served as our Senior Vice President, World Trade since 1999.
Mr. Derrick has served as our Vice President, Corporate Marketing since 2002. From 2000 to 2001, he was Vice President and General Manager of our Physical Verification Division. Since 2008, Mr. Derrick has served as a director of Calypto Design Systems, Inc., a sequential analysis technology company.
Mr. Trebing has been our Corporate Controller and Chief Accounting Officer since December 2011. He previously served as our Director of Finance for Operations since 1999.
Mr. Freed has served as our Vice President, General Counsel, and Secretary since 1995.
Mr. Vishny has served as our Vice President, Chief Human Resources since 2011. He was the Senior Vice President, Human Resources at Conexant Systems, Inc. from 2002 to 2011.


17


PART II
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common stock trades on The NASDAQ Global Select Market under the symbol “MENT.” The following table sets forth for the periods indicated the high and low sales prices for our common stock, as reported by The NASDAQ Global Select Market, and the dividends paid per share:
 
Quarter ended
April 30
 
July 31
 
October 31
 
January 31
Fiscal 2014
 
 
 
 
 
 
 
High Price
$
18.40

 
$
20.78

 
$
23.77

 
$
24.31

Low Price
$
13.21

 
$
17.75

 
$
20.57

 
$
20.51

Dividends Paid
$
0.045

 
$
0.045

 
$
0.045

 
$
0.045

Quarter ended
April 30
 
July 31
 
October 31
 
January 31
Fiscal 2013
 
 
 
 
 
 
 
High Price
$
15.76

 
$
15.75

 
$
17.37

 
$
17.50

Low Price
$
13.70

 
$
12.85

 
$
14.84

 
$
13.32

Dividends Paid
$

 
$

 
$

 
$

As of March 13, 2014, we had 444 stockholders of record.
We commenced the payment of quarterly dividends in the first quarter of fiscal 2014. Our revolving credit facility includes a limit on the amount we can pay for dividends and repurchases of our stock. For more information regarding our credit facility, see Note 5. “Short-Term Borrowings” in Part II, Item 8. “Financial Statements and Supplementary Data.”
The following graph compares the cumulative 5-year total stockholder return on our common stock relative to the cumulative total return of the S&P Application Software Index, the NASDAQ Market Index and the Philadelphia Semiconductor Index.

Note: The stock price shown on the above graph is not necessarily indicative of future performance.

18


 
Period Ending
Company/Market/Peer Group
1/31/2009
 
1/31/2010
 
1/31/2011
 
1/31/2012
 
1/31/2013
 
1/31/2014
Mentor Graphics Corporation
$
100.00

 
$
172.10

 
$
273.39

 
$
297.64

 
$
367.60

 
$
450.79

NASDAQ Market Index
$
100.00

 
$
146.91

 
$
186.66

 
$
196.55

 
$
222.91

 
$
295.15

S&P Application Software Index
$
100.00

 
$
150.14

 
$
225.04

 
$
232.29

 
$
261.73

 
$
303.26

Philadelphia Semiconductor Index
$
100.00

 
$
154.38

 
$
217.77

 
$
204.78

 
$
210.39

 
$
274.70

The table below sets forth information regarding our repurchases of our common stock during the three months ended January 31, 2014:
 
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
November 1 - November 30, 2013

 
$

 

 
$
90,000,021

December 1 - December 31, 2013

 

 

 
$
90,000,021

January 1 - January 31, 2014

 

 

 
$
90,000,021

Total

 
$

 

 
 
On April 18, 2011, we announced a share repurchase program approved by our Board of Directors which authorized the repurchase of up to $150.0 million of our common stock over a three year period. On February 27, 2012, our Board of Directors authorized an additional $50.0 million shares of our common stock to be repurchased under this program, and clarified that the $25.0 million of shares repurchased in April 2011, using proceeds from our issuance of 4.00% Debentures are considered to have been part of this program. On August 21, 2013, our Board of Directors authorized an additional $63.9 million of our common stock to be repurchased under this program.


19


Item 6.
Selected Consolidated Financial Data
In thousands, except percentages and per share data
 
Year ended January 31,
2014
 
2013
 
2012
 
2011
 
2010
Statement of Operations Data
 
 
 
 
 
 
 
 
 
Total revenues
$
1,156,373

 
$
1,088,727

 
$
1,014,638

 
$
914,753

 
$
802,727

Operating income (loss)
$
183,040

 
$
161,633

 
$
112,192

 
$
52,539

 
$
(1,167
)
Net income (loss) attributable to Mentor Graphics shareholders
$
155,258

 
$
138,736

 
$
83,872

 
$
28,584

 
$
(21,889
)
Gross profit percent
84
%
 
83
%
 
83
%
 
83
%
 
83
 %
Operating income (loss) as a percent of revenues
16
%
 
15
%
 
11
%
 
6
%
 
 %
Per Share Data
 
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to Mentor Graphics shareholders (1):
 
 
 
 
 
 
 
 
 
Basic
$
1.33

 
$
1.20

 
$
0.76

 
$
0.27

 
$
(0.23
)
Diluted
$
1.29

 
$
1.17

 
$
0.74

 
$
0.26

 
$
(0.23
)
Weighted average number of shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
113,671

 
110,998

 
110,138

 
107,743

 
96,474

Diluted
116,702

 
114,017

 
112,915

 
109,861

 
96,474

Dividends paid
$
0.18

 
$

 
$

 
$

 
$

As of January 31,
2014
 
2013
 
2012
 
2011
 
2010
Balance Sheet Data
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, and short-term investments
$
297,312

 
$
223,783

 
$
146,499

 
$
133,113

 
$
99,343

Working capital
$
419,122

 
$
293,127

 
$
193,497

 
$
173,417

 
$
71,416

Property, plant, and equipment, net
$
160,165

 
$
162,402

 
$
148,019

 
$
139,340

 
$
121,795

Total assets
$
1,904,109

 
$
1,745,284

 
$
1,550,675

 
$
1,427,978

 
$
1,223,041

Short-term borrowings and current portion of notes payable
$
9,590

 
$
5,964

 
$
15,966

 
$
17,544

 
$
70,146

Long-term portion of notes payable, deferred revenue, long-term, and other noncurrent liabilities
$
292,349

 
$
287,282

 
$
301,397

 
$
291,377

 
$
223,827

Noncontrolling interest with redemption feature
$
15,479

 
$
12,698

 
$
9,266

 
$

 
$

Stockholders’ equity
$
1,185,294

 
$
1,033,479

 
$
866,074

 
$
776,714

 
$
640,017


(1) We have reduced the numerator of our earnings per share calculation by $4,486 for the year ended January 31, 2014 and $5,272 for the year ended January 31, 2013 for the adjustment to increase the noncontrolling interest with redemption feature to its calculated redemption value, recorded directly to retained earnings.                    

20


Item 7.
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 consolidated financial statements and notes included elsewhere in this Form 10-K. 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 I, 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-K. 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-K are made only as of the date of this Form 10-K. 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 and 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, software development, and professional service offices worldwide.
We generally 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 as well as other term licenses where we provide the customer with rights to unspecified or unreleased future products. 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 increases in the capacity of 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

21


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 40% 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 year ended January 31, 2014 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 fiscal 2014 increased by approximately 35% compared to fiscal 2013 primarily due to the timing of term license contract renewals and emulation orders. 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 for fiscal 2014 accounted for approximately 40% of total bookings compared to 35% for fiscal 2013. The number of new customers for fiscal 2014 remained consistent with the levels experienced during fiscal 2013.
Product Development
During the year ended January 31, 2014, 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 year ended January 31, 2014, we introduced new products and upgrades to existing products.
Critical Accounting Policies
We base our discussion and analysis of our financial condition and results of operations upon our 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 valuation of accounts receivable, revenue recognition, business combinations, income taxes, 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 consolidated financial statements. For further discussion of our significant accounting policies, see Note 2. “Summary of Significant Accounting Policies” in Part II, Item 8. “Financial Statements and Supplementary Data.”
Revenue Recognition
We report revenue in two categories based on how revenue is generated: (i) system and software and (ii) service and support.

22


System and software revenues – We derive system and software revenues from the sale of licenses of software products, emulation hardware systems, and finance fee revenues from our long-term installment receivables resulting from product sales. We primarily license our products using two different license types:
1.Term licenses – We use this license type primarily for software sales. This license type provides the customer with the right to use a fixed list of software products for a specified time period, typically three to four years, with payments spread over the license term, and does not provide the customer with the right to use the products after the end of the term. Term license arrangements may allow the customer to share products between multiple locations and remix product usage from the fixed list of products at regular intervals during the license term. We generally recognize product revenue from term license arrangements upon product delivery and start of the license term. In a term license agreement where we provide the customer with rights to unspecified or unreleased future products, we recognize revenue ratably over the license term.
2.Perpetual licenses – We use this license type for software and emulation hardware system sales. This license type provides the customer with the right to use the product in perpetuity and typically does not provide for extended payment terms. We generally recognize product revenue from perpetual license arrangements upon product delivery assuming all other criteria for revenue recognition have been met.
We include finance fee revenues from the accretion of the discount on long-term installment receivables in system and software revenues.
Service and support revenues – 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. We recognize revenues ratably over the support services term. We record professional service revenues as the services are provided to the customer.
We determine whether product revenue recognition is appropriate based upon the evaluation of whether the following four criteria have been met:
1.Persuasive evidence of an arrangement exists – Generally, we use either a customer signed contract or qualified customer purchase order as evidence of an arrangement for both term and perpetual licenses. For professional service engagements, we generally use a signed professional services agreement and a statement of work to evidence an arrangement. Sales through our distributors are evidenced by an agreement governing the relationship, together with binding purchase orders from the distributor on a transaction-by-transaction basis.
2.Delivery has occurred – We generally deliver software and the corresponding access keys to customers electronically. Electronic delivery occurs when we provide the customer access to the software. We may also deliver the software on a compact disc. With respect to emulation hardware systems, we transfer title to the customer upon shipment. Our software license and emulation hardware system agreements generally do not contain conditions for acceptance.
3.Fee is fixed or determinable – We assess whether a fee is fixed or determinable at the outset of the arrangement, primarily based on the payment terms associated with the transaction. We have established a history of collecting under the original contract with installment terms without providing concessions on payments, products, or services. Additionally, for installment contracts, we determine that the fee is fixed or determinable if the arrangement has a payment schedule that is within the term of the licenses and the payments are collected in equal or nearly equal installments, when evaluated on a cumulative basis. If the fee is not deemed to be fixed or determinable, we recognize revenue as payments become due and payable.
Significant judgment is involved in assessing whether a fee is fixed or determinable. We must also make these judgments when assessing whether a contract amendment to a term arrangement (primarily in the context of a license extension or renewal) constitutes a concession. Our experience has been that we are able to determine whether a fee is fixed or determinable for term licenses. If we no longer were to have a history of collecting under the original contract without providing concessions on term licenses, revenue from term licenses would be required to be recognized when payments under the installment contract become due and payable. Such a change could have a material impact on our results of operations.
4.Collectibility is probable – To recognize revenue, we must judge collectibility of the arrangement fees on a customer-by-customer basis pursuant to our credit review process. We typically sell to customers with whom there is a history of successful collection. We evaluate the financial position and a customer’s ability to pay whenever an existing customer purchases new products, renews an existing arrangement, or requests an increase in credit terms. For certain industries for which our products are not considered core to the industry or the industry is generally considered troubled, we impose higher credit standards. If we determine that collectibility is not probable based upon our credit review process or the customer’s payment history, we recognize revenue as payments are received.

23


Multiple element arrangements involving software licenses – For multiple element arrangements involving software and other software-related deliverables, vendor-specific objective evidence of fair value (VSOE) must exist to allocate the total fee among all delivered and non-essential undelivered elements of the arrangement. If undelivered elements of the arrangement are essential to the functionality of the product, we defer revenue until the essential elements are delivered. If VSOE does not exist for one or more non-essential undelivered elements, we defer revenue until such evidence exists for the undelivered elements, or until all elements are delivered, whichever is earlier. If VSOE of all non-essential undelivered elements exists but VSOE does not exist for one or more delivered elements, we recognize revenue using the residual method. Under the residual method, we defer revenue related to the undelivered elements based upon VSOE and we recognize the remaining portion of the arrangement fee as revenue for the delivered elements, assuming all other criteria for revenue recognition are met.
We base our VSOE for certain elements of an arrangement upon the pricing in comparable transactions when the element is sold separately. We primarily base our VSOE for term and perpetual support services upon customer renewal history where the services are sold separately. We also base VSOE for professional services and installation services for emulation hardware systems upon the price charged when the services are sold separately.
Multiple element arrangements involving hardware – For multiple element arrangements involving our emulation hardware systems, we allocate revenue to each element based on the relative selling price of each deliverable. In order to meet the separation criteria to allocate revenue to each element we must determine the standalone selling price of each element using a hierarchy of evidence.
The authoritative guidance requires that, in the absence of VSOE or third-party evidence, a company must develop an estimated selling price (ESP). ESP is defined as the price at which the vendor would transact if the deliverable was sold by the vendor regularly on a standalone basis. A company should consider market conditions as well as entity-specific factors when estimating a selling price. We base our ESP for certain elements in arrangements on either costs incurred to manufacture a product plus a reasonable profit margin or standalone sales to similar customers. In determining profit margins, we consider current market conditions, pricing strategies related to the class of customer, and the level of penetration we have with the customer. In other cases, we may have limited sales on a standalone basis to the same or similar customers and/or guaranteed pricing on future purchases of the same item.
Valuation of Trade Accounts Receivable
We maintain allowances for doubtful accounts on trade account receivables 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 such determination is made.
Income Taxes
Deferred tax assets are recognized for deductible temporary differences, net operating loss carryforwards, and credit carryforwards if it is more likely than not that the tax benefits will be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for valuation allowances. We have recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In the event we determine that we are able to realize our deferred tax assets in the future in excess of our net recorded amount, we would reduce the valuation allowance associated with the deferred tax assets in the period the determination was made, which may result in a tax benefit in the statement of income. Also, if we determine that we are not able to realize all or part of our net deferred tax assets in the future, we would record a valuation allowance on the net deferred tax assets which may result in additional tax expense in the period the determination was made.
We are subject to income taxes in the U.S. and in numerous foreign jurisdictions, and in the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. While we believe the positions we have taken are appropriate, we have reserves for taxes to address potential exposures involving tax positions that are being challenged or that could be challenged by the tax authorities. We record a benefit on a tax position when we determine that it is more likely than not that the position is sustainable upon examination, including resolution of any related appeals or litigation

24


processes, based on the technical merits of the position. For tax positions that are more likely than not to be sustained, we measure the tax position at the largest amount of benefit that has a greater than 50 percent likelihood of being realized when it is effectively settled. We review the tax reserves as circumstances warrant and adjust the reserves as events occur that affect our potential liability for additional taxes.
Business Combinations
When we acquire businesses, we allocate the purchase price, including the fair value of contingent consideration, to acquired tangible assets and liabilities and acquired identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires us to make significant estimates in determining the fair value of contingent consideration as well as acquired assets and assumed liabilities, especially with respect to intangible assets and goodwill. These estimates are based on information obtained from management of the acquired companies, our assessment of this information, and historical experience. These estimates can include, but are not limited to, the cash flows that an acquired business is expected to generate in the future, the cash flows that specific assets acquired with that business are expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable, and if different estimates were used, the purchase price for the acquisition could be allocated to the acquired assets and liabilities differently from the allocation that we have made to the acquired assets and liabilities. In addition, unanticipated events and circumstances may occur that may affect the accuracy or validity of such estimates, and if such events occur, we may be required to adjust the value allocated to acquired assets or assumed liabilities.
We also make significant judgments and estimates when we assign useful lives to the definite lived intangible assets identified as part of our acquisitions. These estimates are inherently uncertain and if we used different estimates, the useful life over which we amortize intangible assets would be different. In addition, unanticipated events and circumstances may occur that may impact the useful life over which we amortize our intangible assets, which would impact our amortization of intangible assets expense and our results of operations.
Goodwill, Intangible Assets, and Long-Lived Assets
We review long-lived assets, including intangible assets with definite lives, for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. We assess the recoverability of our long-lived assets by determining whether their carrying values are greater than the forecasted undiscounted net cash flows of the related assets. If we determine the assets are impaired, we write down the assets to their estimated fair value. We determine fair value based on forecasted discounted net cash flows or appraised values, depending upon the nature of the assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans may change and estimates used may prove to be inaccurate. If our actual results, or the plans and estimates used in future impairment analysis, are lower than the original estimates used to assess the recoverability of these assets, we could incur impairment charges.
We test goodwill and intangible assets with indefinite lives for impairment at least annually and whenever events or changes in circumstances indicate an impairment may exist. In the event that we determine that our goodwill, intangible assets, or other long-lived assets are impaired, we make an adjustment that results in a charge to earnings for the write-down in the period that determination is made.
Special Charges
We record restructuring charges within special charges in the consolidated statements of income in connection with our plans to better align our cost structure with projected operations in the future. We have recorded restructuring charges in connection with employee rebalances based on estimates of the expected costs associated with severance benefits. If the actual cost incurred exceeds the estimated cost, an addition to special charges will be recognized. If the actual cost is less than the estimated cost, a benefit to special charges will be recognized.
Special charges may also include expenses incurred related to certain litigation costs that are unusual in nature due to the significance in variability of timing and amount.
Stock-Based Compensation
We measure stock-based compensation cost at the grant date, based on the fair value of the award, and recognize the expense on a straight-line basis over the employee’s requisite service period. For options and stock awards that vest fully on any

25


termination of service, there is no requisite service period and consequently we recognize the expense fully in the period in which the award is granted.
We estimate the fair value of stock options and purchase rights under our employee stock purchase plans using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model incorporates several highly subjective assumptions including expected volatility, expected term, expected dividends, and interest rates. The input factors used in Black-Scholes option-pricing model are based on subjective future expectations combined with management judgment. If there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation costs. These changes may materially impact the results of operations in the period such changes are made. In addition, if we were to modify any awards, additional charges would be taken.
We did not issue any options in fiscal 2014. For fiscal years 2013 and 2012, when determining expected volatility for options, we include the elements listed below at the weighted percentages presented:
Historical volatility of our shares of common stock at 35%;
Historical volatility of shares of comparable companies at 20%;
Implied volatility of our traded options at 30%; and
Implied volatility of traded options of comparable companies at 15%.
The greatest weighting was provided to the historic volatility of our common stock based on the amount of consistent historic information available. A lesser weighting was applied to the implied volatility of our traded options due to a low volume of trades and shorter terms. We also included the historic and implied volatility of comparable companies in our industry in an effort to capture a broader view of the marketplace.
The relative weighting percentages are periodically reviewed for reasonableness and are subject to change depending on market conditions and our particular facts and circumstances.
In reaching our determination of expected volatility for purchase rights under our employee stock purchase plans, we use the historical volatility of our shares of common stock.
We based the expected term of our stock options on historical experience.


RESULTS OF OPERATIONS
Revenues and Gross Profit
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
System and software revenues
$
737.8

 
8
%
 
$
681.9

 
8
%
 
$
631.5

System and software gross profit
$
668.9

 
10
%
 
$
609.8

 
8
%
 
$
566.8

Gross profit percent
91
%
 
 
 
89
%
 
 
 
90
%
Service and support revenues
$
418.6

 
3
%
 
$
406.8

 
6
%
 
$
383.1

Service and support gross profit
$
300.4

 
4
%
 
$
289.2

 
5
%
 
$
274.4

Gross profit percent
72
%
 
 
 
71
%
 
 
 
72
%
Total revenues
$
1,156.4

 
6
%
 
$
1,088.7

 
7
%
 
$
1,014.6

Total gross profit
$
969.3

 
8
%
 
$
899.0

 
7
%
 
$
841.2

Gross profit percent
84
%
 
 
 
83
%
 
 
 
83
%
System and Software
 

26


Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
Upfront license revenues
$
641.6

 
10
 %
 
$
584.3

 
8
%
 
$
541.7

Ratable license revenues
96.2

 
(1
)%
 
97.6

 
9
%
 
89.8

Total system and software revenues
$
737.8

 
8
 %
 
$
681.9

 
8
%
 
$
631.5

We derive system and software revenues from the sale of licenses of software products and emulation and other hardware systems, including finance fee revenues from our long-term installment receivables resulting from 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 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, term licenses where we provide the customer with rights to unspecified or unreleased future products, and finance fees from the accretion of the discount on long-term installment receivables.
Ten customers accounted for approximately 40% of system and software revenues for fiscal 2014 and fiscal 2013 and approximately 45% for fiscal 2012. No single customer accounted for 10% or more of total revenues for fiscal years 2014, 2013, and 2012.
System and software revenues increased for fiscal 2014 compared to fiscal 2013 primarily as a result of increased software license revenues driven by the timing of contract renewals.
System and software revenues increased for fiscal 2013 compared to fiscal 2012 primarily due to an increase in sales of scalable verification products. The effect of acquisitions completed in fiscal 2013 and fiscal 2012 on fiscal 2013 system and software revenues was $13.6.
System and software gross profit percentage was higher for fiscal 2014 compared to fiscal 2013 primarily due to a more favorable product mix and reduced amortization of purchased technology.
Service and Support
We derive service and support revenues from software and hardware post-contract maintenance or support services and professional services, which includes consulting, training, and other services. Professional services are a lower margin offering which is staffed according to fluctuations in demand. Support services operate under a less variable cost structure.
The increase in service and support revenues for fiscal 2014 compared to fiscal 2013 was driven primarily by increased support revenues of $7.7 resulting from an increase in our installed base.
The increase in service and support revenues for fiscal 2013 compared to fiscal 2012 was driven primarily by increased support revenues of $18.7 due to an increase in installed base including the effect of acquisitions completed in fiscal 2013 and in fiscal 2012 of $9.6.
Geographic Revenues Information
Revenue by Geography
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
North America
$
513.2

 
7
%
 
$
481.1

 
16
%
 
$
416.1

Europe
241.4

 
(8
%)
 
261.4

 
6
%
 
247.1

Japan
113.8

 
(11
%)
 
127.8

 
10
%
 
116.5

Pacific Rim
288.0

 
32
%
 
218.4

 
(7
%)
 
234.9

Total revenue
$
1,156.4

 
6
%
 
$
1,088.7

 
7
%
 
$
1,014.6

The decrease in revenues in Japan for fiscal 2014 compared to fiscal 2013 is due to foreign exchange offset in part by the favorable impact of the timing of contract renewals. The increase in revenues in the Pacific Rim for fiscal 2014 compared to fiscal 2013 is primarily due to the timing of contract renewals. The changes in revenues in North America and Japan for fiscal 2013 compared to fiscal 2012 were the result of timing and geographic location 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 fiscal year 2014, approximately one-third of European and approximately 90% of Japanese revenues were subject to exchange rate fluctuations

27


as they were booked in local currencies. For fiscal year 2013, approximately one-fourth of European and three-fourths of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. For fiscal year 2012, approximately one-third of European and substantially all Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies.
Foreign currency had an unfavorable impact of $21.8 for fiscal 2014 compared to fiscal 2013 primarily as a result of the strengthening of the U.S. dollar against the Japanese yen. Foreign currency had an unfavorable impact of $5.4 for fiscal 2013 compared to fiscal 2012 primarily as a result of the strengthening of the U.S. dollar against the Japanese yen and euro.
For additional description of how changes in foreign exchange rates affect our consolidated financial statements, see discussion in Part II, Item 7A., “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%):

Year ended January 31,
2014
 
2013
 
2012
Revenues:
 
 
 
 
 
IC Design to Silicon
40
%
 
35
%
 
40
%
Scalable Verification
25
%
 
25
%
 
25
%
Integrated System Design
20
%
 
25
%
 
20
%
New and Emerging Products
5
%
 
5
%
 
5
%
Services and Other
10
%
 
10
%
 
10
%
Total revenues
100
%
 
100
%
 
100
%
Certain reclassifications have been made between categories in the fiscal 2013 and 2012 presentation to be consistent with the fiscal 2014 presentation.
Operating Expenses
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
Research and development
$
348.8

 
11
%
 
$
314.0

 
1
%
 
$
310.8

Marketing and selling
342.8

 
1
%
 
338.7

 
4
%
 
326.6

General and administration
75.5

 
7
%
 
70.7

 
(5
%)
 
74.8

Equity in earnings of Frontline
(4.1
)
 
128
%
 
(1.8
)
 
(22
%)
 
(2.3
)
Amortization of intangible assets
6.2

 
5
%
 
5.9

 
%
 
5.9

Special charges
16.9

 
71
%
 
9.9

 
(25
%)
 
13.2

Total operating expenses
$
786.1

 
7
%
 
$
737.4

 
1
%
 
$
729.0

Selected Operating Expenses as a Percentage of Total Revenues
 
Year ended January 31,
2014
 
2013
 
2012
Research and development
30
%
 
29
%
 
31
%
Marketing and selling
30
%
 
31
%
 
32
%
General and administration
7
%
 
6
%
 
7
%
Total selected operating expenses
67
%
 
66
%
 
70
%

28


Research and Development
Research and development expenses increased by $34.8 for fiscal 2014 compared to fiscal 2013 primarily due to an increase in the number of employees, resulting in higher compensation. Research and development expenses increased by $3.2 for fiscal 2013 compared to fiscal 2012. The components of these changes are summarized as follows:
 
 
Change
Year ended January 31,
2014 vs 2013
 
2013 vs 2012
Salaries, variable compensation, and benefits expenses
$
17.6

 
$
(9.9
)
Supplies and equipment
3.4

 
(0.4
)
Expenses associated with acquired businesses
2.7

 
7.3

Outside services
2.5

 
0.8

Reduction in tax credits
2.2

 
0.7

Stock compensation
2.0

 
0.7

Other expenses
4.4

 
4.0

Total change in research and development expenses
$
34.8

 
$
3.2

Marketing and Selling
Marketing and selling expenses increased by $4.1 for fiscal 2014 compared to fiscal 2013 and increased by $12.1 for fiscal 2013 compared to fiscal 2012. The components of these changes are summarized as follows:
 
 
Change
Year ended January 31,
2014 vs 2013
 
2013 vs 2012
Salaries, variable compensation, and benefits expenses
$
1.2

 
$
8.0

Expenses associated with acquired businesses
0.2

 
5.9

Other expenses
2.7

 
(1.8
)
Total change in marketing and selling expenses
$
4.1

 
$
12.1

General and Administration
General and administration expenses increased by $4.8 for fiscal 2014 compared to fiscal 2013 and decreased by $4.1 for fiscal 2013 compared to fiscal 2012. The components of these changes are summarized as follows:
 
 
Change
Year ended January 31,
2014 vs 2013
 
2013 vs 2012
Salaries, variable compensation, and benefits expenses
$
2.0

 
$
(2.8
)
Stock compensation
2.1

 
(0.5
)
Expenses associated with acquired businesses

 
1.8

Other expenses
0.7

 
(2.6
)
Total change in general and administration expenses
$
4.8

 
$
(4.1
)
We have reclassified litigation costs related to patent litigation involving us, Emulation and Verification Engineering, S.A. and EVE-USA, Inc. (together EVE), and Synopsys, Inc. (Synopsys) from general and administration to special charges for fiscal 2013. A further description is provided in Note 2. "Summary of Significant Accounting Policies" in Part II, Item 8. "Financial Statements and Supplementary Data."
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. For fiscal 2014 compared to fiscal 2013, we experienced favorable currency movements of $6.4 in total operating expenses, primarily due to movements in the Japanese yen. For fiscal 2013 compared to fiscal 2012, we experienced favorable currency movements of $13.2 in total operating expenses, primarily due to movements in the euro and the Indian rupee. The impact of these currency effects is reflected in the movements in operating expenses detailed above.

29


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. As such, 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 twelve months ended December 31, 2013, 2012, and 2011:
 
Year ended December 31,
2013
 
2012
 
2011
Mentor's share of net income-as reported
$
5.5

 
$
6.8

 
$
7.3

Amortization of purchased technology and other identified intangible assets
(1.4
)
 
(5.0
)
 
(5.0
)
Equity in earnings of Frontline
$
4.1

 
$
1.8

 
$
2.3

Special Charges
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
Litigation costs
$
11.6

 
222
%
 
$
3.6

 
%
 
$

Employee severance and related costs
4.4

 
10
%
 
4.0

 
(52
%)
 
8.4

Other costs
0.9

 
(61
%)
 
2.3

 
(52
%)
 
4.8

Total special charges
$
16.9

 
71
%
 
$
9.9

 
(25
%)
 
$
13.2

Special charges may include expenses incurred related to certain litigation costs, employee severance, acquisitions, excess facility costs, and assets related charges.
Litigation costs consist of professional service fees related to patent litigation involving us, EVE, and Synopsys regarding emulation technology. These costs have been reclassified from general administration for fiscal 2013 as further described in Note 2. "Summary of Significant Accounting Policies" in Part II, Item 8. "Financial Statements and Supplementary Data."
Employee severance and related costs primarily consist of costs incurred for employee terminations due to a reduction of personnel resources driven by modifications of business strategy or business emphasis. 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.
Interest Expense
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
Interest Expense
$
19.5

 
3
%
 
$
18.9

 
(40
)%
 
$
31.4

The decrease in interest expense for fiscal 2013 compared to fiscal 2012 was primarily due to the higher expenses recorded in fiscal 2012 related to the repayment of debt in April 2011. This resulted in losses of $11.5 on the early extinguishment of debt, which included a $6.2 write-off of the net unamortized debt discount, a $3.5 premium for the redemption of the 6.25% Convertible Subordinated Debentures, and a write-off of $1.8 for the remaining portion of unamortized debt issuance costs.
Provision for Income Taxes
 
Year ended January 31,
2014
 
Change
 
2013
 
Change
 
2012
Income tax expense (benefit)
$
9.5

 
252
%
 
$
2.7

 
345
%
 
$
(1.1
)
In fiscal 2014, our income before taxes of $163.1 consisted of $163.8 of pre-tax income in foreign jurisdictions and a pre-tax loss of $0.7 in the U.S., reflecting substantial earnings by certain foreign operations, including our Irish subsidiaries, and a higher proportion of our operating expenses and financing costs occurring in the U.S.

30


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.
Our effective tax rate was 6% for fiscal 2014. Our tax expense differs from tax expense computed at the U.S. federal statutory rate primarily due to:
The benefit of lower tax rates on earnings of foreign subsidiaries;
Utilization of net operating loss carryforwards for which no benefit was previously recognized;
Reduction in reserves for uncertain tax positions; and
The application of tax incentives for research and development.
These differences are partially offset by:
Repatriation of foreign subsidiary earnings to the U.S.;
Non-deductible equity compensation expense; and
Withholding taxes.

We repatriated foreign subsidiary earnings to the U.S. in fiscal 2014, but the U.S. tax impacts were offset by net operating loss carryforwards for which no tax benefits had been previously recognized, and therefore the repatriation had no net impact on our tax provision or effective tax rate.
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 carryovers. We calculate the deferred tax assets and liabilities using the enacted laws and tax rates 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 that 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 continue to evaluate the realizability of our U.S. and foreign deferred tax assets on a periodic basis.

From January 31, 2013 to January 31, 2014, net deferred tax assets decreased from $14.0 to $5.5. Gross deferred tax assets decreased by $10.6 from January 31, 2013 to January 31, 2014, principally due to the utilization of net operating losses in the U.S. There was a $25.6 increase in deferred tax liabilities from January 31, 2013 to January 31, 2014 and a valuation allowance decrease of $27.7 from January 31, 2013 to January 31, 2014. The changes in both the deferred tax liabilities and the valuation allowance principally related to an increase in the amount, and tax thereon, of foreign subsidiary earnings treated as not permanently reinvested.

The liability for income taxes associated with net uncertain tax positions was $18.8 as of January 31, 2014 and $28.2 as of January 31, 2013. As of January 31, 2014, within the liability, $0.4 was classified as short-term liabilities in income tax payable in our consolidated balance sheet as we generally anticipate the settlement of these liabilities will require payment of cash within the next twelve months. The remaining $18.4 of income tax associated with uncertain tax positions was classified as a long-term income tax liability. We expect uncertain tax positions of $18.7, if recognized, would favorably affect our effective tax rate.

Adjustment to Earnings Release

On February 27, 2014, we issued a press release with our balance sheet as of January 31, 2014. In the course of our internal review process for this Annual Report on Form 10-K, we subsequently reclassified and netted deferred taxes of $1.9 affecting current assets and long-term liabilities, which was not reflected in the February 27th earnings release. These changes had no impact on reported net income or earnings per share for the year ended January 31, 2014.

31


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 under 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 January 31, 2014, we have cash totaling $205.6 held by our foreign subsidiaries. A significant portion of our offshore cash is accessible without a significant tax cost as some of our foreign earnings were previously taxed in the U.S. and other foreign earnings may be sheltered from U.S. tax by net operating loss and tax credit carryforwards. 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 U.S. 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 and cash equivalents 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. While we monitor daily the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets.
We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis:
Current cash balances;
Anticipated cash flows from operating activities, including the effects of selling and financing customer term receivables;
Amounts available under existing revolving credit facilities; and
Other available financing sources, such as the issuance of debt or equity securities.
We have experienced no difficulties to date in raising debt. However, capital markets have been volatile, and we cannot assure you that we will be able to raise debt or equity capital on acceptable terms, if at all.
Cash Flow Information
 
Year ended January 31,
2014
 
2013
Cash provided by operating activities
$
149.7

 
$
139.3

Cash used in investing activities
$
(56.4
)
 
$
(60.8
)
Cash (used in) provided by financing activities
$
(21.0
)
 
$
1.9

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. 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
 

32


As of January 31,
2014
 
2013
Trade accounts receivable
$
454.5

 
$
412.2

Term receivables, short-term (included in trade accounts receivable on the balance sheet)
$
274.7

 
$
233.9

Term receivables, long-term
$
270.4

 
$
250.5

Average days sales outstanding in trade accounts receivable, including the short-term portion of term receivables
102

 
112

Average days sales outstanding in trade accounts receivable, excluding the short-term portion of term receivables
40

 
48

The decrease in the average days sales outstanding in short-term receivables as of January 31, 2014 was due to an increase in revenue in the fourth quarter of fiscal 2014 compared to fiscal 2013 partially offset by an increase in accounts receivable as of January 31, 2014 compared to January 31, 2013.
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, 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 $545.0 as of January 31, 2014 compared to $484.4 as of January 31, 2013. The increase in term receivables as of January 31, 2014 compared to January 31, 2013 was due to an increase in revenue for fiscal 2014 compared to fiscal 2013.
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 $22.9 for fiscal 2014 compared to $20.2 for fiscal 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 fiscal 2015.
Investing Activities
Cash used in investing activities for fiscal 2014 primarily consisted of cash paid for capital expenditures and acquisitions of business and equity interests.
Expenditures for property, plant, and equipment decreased to $30.8 for fiscal 2014 compared to $45.1 for fiscal 2013. The expenditures for property, plant, and equipment for fiscal 2014 were primarily a result of spending on information technology and infrastructure improvements within our facilities.
During fiscal 2014, we acquired certain assets of four privately-held companies, each constituting a business, for a total purchase price of $19.3. 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.
During the year ended January 31, 2014, we invested excess cash of $7.8 into certificates of deposit with an annual interest rate of 8.75%. We sold $3.1 of these investments during the year ended January 31, 2014.
Financing Activities
For fiscal 2014, cash used in financing activities consisted primarily repurchases of our common stock and dividends paid, offset in part by proceeds from the issuance of common stock.

In April 2011, we announced a share repurchase program under which we may purchase up to $150.0 of our common stock over a three year period through April 2014. In February 2012, our Board of Directors approved an increase in the amount we may repurchase under this program from $150.0 to $200.0 and on August 21, 2013, our Board of Directors approved an additional increase in the amount we may repurchase under this program of $63.9. During the year ended January 31, 2014, we repurchased 2.6 shares of common stock for $50.0, compared to 2.2 shares for $33.9 during the year ended January 31, 2013. As of January 31, 2014, $90.0 remained available for repurchase under this program.

On March 7, 2013, our Board of Directors announced the adoption of a dividend policy under which we commenced payment of cash dividends at an annual rate of $0.18 per share of common stock. Accordingly, during the year ended January 31, 2014, we paid quarterly dividends of $0.045 per share of outstanding common stock for a total of $20.4. On February 27, 2014, we announced an increase in the quarterly dividend to $0.05 per share. 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.

33



The terms of our revolving credit facility limit 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 $145.2 is available for common stock repurchases or dividend payments under this limit as of January 31, 2014.
Other factors affecting liquidity and capital resources
4.00% Debentures due 2031
In April 2011, we issued $253.0 of the 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures). Interest on the 4.00% Debentures is payable semi-annually in April and October.
The 4.00% Debentures are convertible, under certain circumstances, into our common stock at a conversion rate, as of January 31, 2014, of 49.133 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.35 per share) for a total of 12.4 shares. These circumstances include:
The market price of our common stock exceeding 120% of the conversion price, or $24.42 per share as of January 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.
As of January 31, 2014, the if-converted value of the 4.00% Debentures exceeded the principal amount by $5.6.
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 in some circumstances will also be entitled to receive a make whole premium upon conversion.
As the result of us declaring dividends during the year ended January 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 49.133 shares of our common stock for each one thousand dollars in principal amount of the 4.00% Debentures (equivalent to a conversion price of $20.35 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 6. "Notes Payable" in Part II, Item 8. "Financial Statements and Supplementary Data."
Revolving Credit Facility

34


On May 24, 2013, we amended our syndicated, senior, unsecured, four-year revolving credit facility extending the termination date to May 24, 2017.
The revolving credit facility has a maximum borrowing capacity of $125.0. We have the option to pay interest on this revolving credit facility based on:
(i)
London Interbank Offered Rate (LIBOR) with varying maturities which are 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.
The base rate is defined as the highest of:
(i)
The federal funds rate, as defined, plus 0.5%;
(ii)
The prime rate of the lead bank; or
(iii)
One-month LIBOR plus 1.0%.
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.
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 January 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.
We had no borrowings against the revolving credit facility during fiscal 2014.
For further information on the revolving credit facility, see Note 5. “Short-Term Borrowings” in Part II, Item 8. “Financial Statements and Supplementary Data.”
OFF-BALANCE SHEET ARRANGEMENTS
We do not have off-balance sheet arrangements, financings, or other similar relationships with unconsolidated entities or other persons, also known as special purpose entities. In the ordinary course of business, we lease certain real properties, primarily field sales offices, research and development facilities, and equipment.
CONTRACTUAL OBLIGATIONS
We are contractually obligated to make the following payments as of January 31, 2014:
 
 
Payments due by period
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
More than 5
years
Notes payable
$
253.0

 
$

 
$

 
$

 
$
253.0

Interest on debt
173.6

 
10.1

 
20.2

 
20.2

 
123.1

Other liabilities (1)
19.6

 
5.5

 
7.0

 
0.4

 
6.7

Other borrowings
9.6

 
9.6

 

 

 

Operating leases
70.2

 
23.1

 
30.3

 
9.9

 
6.9

Total contractual obligations
$
526.0

 
$
48.3

 
$
57.5

 
$
30.5

 
$
389.7

(1)
Our balance sheet as of January 31, 2014 includes additional long-term taxes payable of $22.7 related to tax positions for which the timing of the ultimate resolution is uncertain. At this time, we are unable to make a reasonably reliable estimate of the period of cash settlement with the respective the tax authorities and the total amount of taxes payable. The timing of such tax payments may depend on the resolution of current and future tax examinations which cannot be estimated. As a result, this amount is not included in the above table.

35


OUTLOOK FOR FISCAL 2015
We expect revenues for the first quarter of fiscal 2015 to be approximately $245.0, with earnings per share for the same period of approximately break-even. For the full year fiscal 2015, we expect revenues to be approximately $1.237 billion, with earnings per share of approximately $1.50.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Unless otherwise indicated, all numerical references 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 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 January 31, 2014. In accordance with our investment policy, all short-term investments mature in twelve months or less.
 
Principal (notional) amounts in U.S. dollars
Carrying
Amount
 
Average Fixed
Interest Rate
Cash equivalents – fixed rate
$
1.3

 
3.00
%
Short-term investments - fixed rate
$
4.0

 
8.75
%
Total fixed rate interest bearing instruments
$
5.3

 
7.36
%
We have convertible subordinated debentures with a principal balance of $253.0 outstanding with a fixed interest rate of 4.00% as of January 31, 2014 and January 31, 2013. Interest rate changes for fixed rate debt affect the fair value of the debentures 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. 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 and the repurchase of our common stock. As of January 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, including interest rate options, see Note 5. "Short-Term Borrowings" in Part II, Item 8. "Financial Statements and Supplementary Data."

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 assets and liabilities.

36


The following table provides volume information about our foreign currency forward program. The information provided is in U.S. 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.
 
As of January 31,
2014
 
2013
 
Gross
Notional
Amount
 
Weighted
Average
Contract
Rate
 
Gross
Notional
Amount
 
Weighted
Average
Contract
Rate
Forward Contracts:
 
 
 
 
 
 
 
Japanese yen
$
54.7

 
103.91

 
$
40.6

 
90.11

Euro
29.6

 
0.74

 
27.0

 
0.74

British pound
22.1

 
0.61

 
13.9

 
0.63

Swedish krona
12.7

 
6.47

 
13.1

 
6.52

Indian rupee
12.0

 
62.03

 
3.8

 
54.32

Canadian dollar
6.0

 
1.10

 
9.5

 
0.99

Other (1)
32.3

 

 
24.9

 

Total forward contracts
$
169.4

 
 
 
$
132.8

 
 
 
(1)
Other includes currencies which are the Chinese yuan, Armenian dram, Taiwan dollar, Israeli shekel, Russian rubles, Norwegian kroner, Swiss franc, Danish kroner, Polish zloty, Hungarian forints, Korean won, and Singapore dollar.

37


Item 8.
Financial Statements and Supplementary Data
Mentor Graphics Corporation
Consolidated Statements of Income
 
Year ended January 31,
2014
 
2013
 
2012
In thousands, except per share data
 
 
 
 
 
Revenues:
 
 
 
 
 
System and software
$
737,790

 
$
681,881

 
$
631,549

Service and support
418,583

 
406,846

 
383,089

Total revenues
1,156,373

 
1,088,727

 
1,014,638

Cost of revenues:
 
 
 
 
 
System and software
65,288

 
64,280

 
54,972

Service and support
118,221

 
117,609

 
108,690

Amortization of purchased technology
3,598

 
7,801

 
9,796

Total cost of revenues
187,107

 
189,690

 
173,458

Gross profit
969,266

 
899,037

 
841,180

Operating expenses:
 
 
 
 
 
Research and development
348,817

 
313,962

 
310,758

Marketing and selling
342,799

 
338,653

 
326,608

General and administration
75,543

 
70,692

 
74,811

Equity in earnings of Frontline
(4,092
)
 
(1,764
)
 
(2,268
)
Amortization of intangible assets
6,230

 
5,915

 
5,905

Special charges
16,929

 
9,946

 
13,174

Total operating expenses
786,226

 
737,404

 
728,988

Operating income
183,040

 
161,633

 
112,192

Other (expense) income, net
(520
)
 
(1,432
)
 
1,576

Interest expense
(19,452
)
 
(18,866
)
 
(31,444
)
Income before income tax
163,068

 
141,335

 
82,324

Income tax expense (benefit)
9,510

 
2,701

 
(1,063
)
Net income
$
153,558

 
$
138,634

 
$
83,387

Less: Loss attributable to noncontrolling interest
(1,700
)
 
(102
)
 
(485
)
Net income attributable to Mentor Graphics shareholders
$
155,258

 
$
138,736

 
$
83,872

Net income per share:
 
 
 
 
 
Basic
$
1.33

 
$
1.20

 
$
0.76

Diluted
$
1.29

 
$
1.17

 
$
0.74

Weighted average number of shares outstanding:
 
 
 
 
 
Basic
113,671

 
110,998

 
110,138

Diluted
116,702

 
114,017

 
112,915

Cash dividends declared per common share
$
0.18

 
$

 
$

See accompanying notes to consolidated financial statements.


38


Mentor Graphics Corporation
Consolidated Statements of Comprehensive Income
Year ended January 31,
2014
 
2013
 
2012
In thousands
 
 
 
 
 
Net income
$
153,558

 
$
138,634

 
$
83,387

Other comprehensive loss, net of tax:
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
Change in unrealized gain (loss) on derivative instruments
1,653

 
829

 
(402
)
Less: reclassification adjustment for net gain (loss) included in net income
1,599

 
636

 
(199
)
Net change, net of tax expense (benefit) of $ - , $1, $(73)
54


193


(203
)
Change in accumulated translation adjustment
(6,790
)
 
(3,110
)
 
(3,149
)
Change in pension liability, net of tax expense (benefit) of $72, $(284), $110
135

 
(420
)
 
212

Other comprehensive loss
(6,601
)

(3,337
)

(3,140
)
Comprehensive income
146,957


135,297


80,247

Less amounts attributable to the noncontrolling interest:
 
 
 
 
 
Net loss
(1,700
)
 
(102
)
 
(485
)
Change in accumulated translation adjustment
(5
)
 
(56
)
 
(127
)
Comprehensive loss attributable to the noncontrolling interest
(1,705
)

(158
)

(612
)
Comprehensive income attributable to Mentor Graphics shareholders
$
148,662


$
135,455


$
80,859


See accompanying notes to consolidated financial statements.


39


Mentor Graphics Corporation
Consolidated Balance Sheets
As of January 31,
2014
 
2013
In thousands
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
293,322

 
$
223,783

Short-term investments
3,990

 

Trade accounts receivable, net of allowance for doubtful accounts of $5,469 as of January 31, 2014 and $5,331 as of January 31, 2013
454,483

 
412,245

Other receivables
15,506

 
10,974

Inventory
25,121

 
18,036

Prepaid expenses and other
24,031

 
24,941

Deferred income taxes
13,656

 
14,973

Total current assets
830,109

 
704,952

Property, plant, and equipment, net
160,165

 
162,402

Term receivables
270,365

 
250,497

Goodwill
549,044

 
535,932

Intangible assets, net
22,799

 
21,838

Other assets
71,627

 
69,663

Total assets
$
1,904,109

 
$
1,745,284

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Short-term borrowings
$
9,590

 
$
5,964

Accounts payable
21,548

 
20,906

Income taxes payable
3,365

 
9,180

Accrued payroll and related liabilities
102,848

 
101,354

Accrued and other liabilities
42,457

 
40,662

Deferred revenue
231,179

 
233,759

Total current liabilities
410,987

 
411,825

Notes payable
224,261

 
218,546

Deferred revenue
17,398

 
17,755

Income tax liability
18,431

 
22,663

Other long-term liabilities
32,259

 
28,318

Total liabilities
703,336

 
699,107

Commitments and contingencies (Note 8)

 

Noncontrolling interest with redemption feature
15,479

 
12,698

Stockholders’ equity:
 
 
 
Common stock, no par value, 300,000 shares authorized as of January 31, 2014 and January 31, 2013; 115,722 shares issued and outstanding as of January 31, 2014 and 112,902 shares issued and outstanding as of January 31, 2013
838,939

 
810,902

Retained earnings
327,552

 
197,178

Accumulated other comprehensive income
18,803

 
25,399

Total stockholders’ equity
1,185,294

 
1,033,479

Total liabilities and stockholders’ equity
$
1,904,109

 
$
1,745,284

See accompanying notes to consolidated financial statements.

40


Mentor Graphics Corporation
Consolidated Statements of Cash Flows
 
Year ended January 31,
2014
 
2013
 
2012
In thousands
 
 
 
 
 
Operating Cash Flows:
 
 
 
 
 
Net income
$
153,558

 
$
138,634

 
$
83,387

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation of property, plant, and equipment
34,563

 
33,305

 
31,948

Amortization of intangible assets, debt costs and other
17,891

 
20,246

 
22,239

Loss on debt extinguishment

 

 
3,518

Write-off of debt discount and debt issuance costs

 

 
8,010

Stock-based compensation
29,350

 
23,697

 
21,658

Deferred income taxes
8,550

 
(1,634
)
 
2,754

Changes in other long-term liabilities
(3,708
)
 
(6,143
)
 
2,889

Gain on conversion of equity method investment to controlling interest

 

 
(1,519
)
Dividends received from unconsolidated entities, net of equity in income
1,290

 
4,358

 
4,874

Other
(11
)
 
74

 
(7
)
Changes in operating assets and liabilities, net of effect of acquired businesses:
 
 
 
 
 
Trade accounts receivable, net
(43,811
)
 
(58,389
)
 
(8,915
)
Prepaid expenses and other
(17,774
)
 
(21,861
)
 
(16,295
)
Term receivables, long-term
(21,285
)
 
(30,980
)
 
(54,637
)
Accounts payable and accrued liabilities
4,473

 
(2,720
)
 
(3,122
)
Income taxes receivable and payable
(10,487
)
 
(5,084
)
 
(11,725
)
Deferred revenue
(2,896
)
 
45,784

 
18,881

Net cash provided by operating activities
149,703

 
139,287

 
103,938

Investing Cash Flows:
 
 
 
 
 
Proceeds from the sales and maturities of short-term investments
3,112

 

 

Purchases of short-term investments
(7,820
)
 

 

Increase in restricted cash

 

 
(3,977
)
Purchases of property, plant, and equipment
(30,761
)
 
(45,130
)
 
(41,555
)
Acquisitions of businesses and equity interests and other intangible assets, net of cash acquired
(20,906
)
 
(15,652
)
 
(15,260
)
Net cash used in investing activities
(56,375
)
 
(60,782
)
 
(60,792
)
Financing Cash Flows:
 
 
 
 
 
Proceeds from issuance of common stock
53,013

 
46,756

 
37,460

Repurchase of common stock
(49,995
)
 
(33,914
)
 
(89,996
)
Tax benefit from share options exercised
386

 
266

 

Dividends paid
(20,398
)
 

 

Net increase (decrease) in short-term borrowing
3,748

 
(8,149
)
 
(1,284
)
Debt and equity issuance costs

 

 
(9,020
)
Proceeds from notes payable

 

 
253,000

Repayments of notes payable

 

 
(219,919
)
Repayments of other borrowings
(7,762
)
 
(3,016
)
 

Net cash (used in) provided by financing activities
(21,008
)
 
1,943

 
(29,759
)
Effect of exchange rate changes on cash and cash equivalents
(2,781
)
 
(3,164
)
 
(1
)
Net change in cash and cash equivalents
69,539

 
77,284

 
13,386

Cash and cash equivalents at the beginning of the period
223,783

 
146,499

 
133,113

Cash and cash equivalents at the end of the period
$
293,322

 
$
223,783

 
$
146,499

See accompanying notes to consolidated financial statements.

41


Mentor Graphics Corporation
Consolidated Statements of Stockholders’ Equity
 
 
Common Stock
 
Retained Earnings (Accumulated Deficit)
 
Accumulated Other
Comprehensive
Income
 
Total
Stockholders’
Equity
 
Noncontrolling
Interest with
Redemption Feature
 
Shares
 
Amount
 
 
 
 
In thousands
 
 
 
 
 
 
 
 
 
 
 
Balance as of January 31, 2011