10-K 1 ment-20170131x10k.htm FORM 10-K Document

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, 2017
Commission file number 1 – 34795
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logo20170131a02.jpg
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)
Registrant's telephone number, including area code (503) 685-7000
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
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 (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark 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 $2,309,898,916 on July 31, 2016 based upon the last price of the Common Stock on that date reported in the NASDAQ Global Select Market. On March 15, 2017, there were 110,487,092 shares of the registrant’s Common Stock outstanding.
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Mentor Graphics Corporation
Annual Report on Form 10-K
Year to date January 31, 2017

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 (the Company) is a technology leader in electronic design automation (EDA). We provide software and hardware design solutions, as well as complementary consulting and customer support services, which 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 and test with our products include integrated circuits (ICs), printed circuit boards (PCBs), field programmable gate arrays (FPGAs), embedded systems and software, and wire harness systems. Our products are used in the design and development of a diverse set of electronic products, including transportation electronics, internet of things (IoT) platforms and systems, computers, medical devices, industrial electronics, manufacturing systems, and wireless communications infrastructure. As silicon manufacturing process geometries shrink, our customers are creating electronic systems on a single IC. These devices are called a system-on-chip (SoC). This trend has become relevant to the everyday consumer as consumer electronics have become smaller, more portable and more sophisticated.

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 85 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 available on our website.

PRODUCTS
Our products are capable of handling the most complex designs at the IC, package, PCB and system levels. These products are essential tools that allow engineers to meet the ever increasing pressure of increased design complexity, shrinking time to market schedules and demand for top quality, fault-free products. Providing engineers with the tools and services to meet their design objectives in a productive, efficient and exacting manner is core to our business. Here is a typical hardware design process:
Electrical engineers begin the design process by describing and specifying the architectural, behavioral, functional, and structural characteristics of an IC, FPGA, PCB, or electronic system and its 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 including: Scalable Verification, IC Design to Silicon, Integrated System Design, New and Emerging Products, and Services and Other. Each category, except Services and Other, 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.”

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.

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Scalable Verification
Scalable VerificationTM tools allow engineers to verify that their complex IC and FPGA designs function as intended by simulating and debugging the design. Functional errors are a leading cause of design revisions that slow down an electronic system’s time-to-market and reduce its profitability.

The Questa® platform includes support for hardware description language simulation, including System Verilog simulation, and methodologies using assertions, 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 (ASICs), SoCs, and FPGAs.

Together with digital simulation products, we offer analog/mixed-signal simulation tools. Analog/mixed signal ICs are found in virtually all electronic products today, from smart phones to smart TVs, from hybrid electric cars to fitness bands. Our analog/mixed-signal simulation tools enable our customers to simulate and verify both the functionality and performance of complex circuits before mass production. Our Analog FastSPICE™ platform includes nanometer (nm, by definition one-billionth of a meter) circuit simulation, an analog characterization environment and device noise analysis. Other analog/mixed signal simulation products we offer include the Eldo® and ADVance MS for classic analog/mixed-signal design.

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 in ICs in the nanometer era and increasing design sizes have enabled ever increasing functionality on a single IC. Today’s most advanced ICs are being produced in a 10 nm process with ongoing test chips produced at 7 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 geometries within ICs have changed how technologists 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 the 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 manipulate the light used to create ICs to make structures on the IC that are finer than would be possible with conventional exposures. 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 130 nm to 7 nm.
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

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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 used in verifying the completeness of electrostatic discharge protection circuitry which affects both manufacturing yield and the long-term reliability of an IC.

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™ (embedded deterministic test). A suite of test analysis products is also available that leverages test data and layout-aware diagnosis capabilities for silicon debug and yield analysis.

Our Tanner EDA tool suite facilitates the design, layout and verification of analog/mixed signal ICs, MEMS (micro-electro-mechanical systems) and IoT devices. Our suite of analog tools includes schematic design, simulation, physical layout, schematic driven layout, physical verification, and post-layout simulation. Our mixed signal suite additionally offers the ability to design and implement digital logic. The Tanner EDA MEMS suite provides the unique capabilities required to design and verify integrated electronic and mechanical devices.

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 and slower time to market.

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, signal and power integrity analysis, simulation, and verification of the PCB design:
The Xpedition® Series product line is our principal PCB design family of products and is used by 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 every point in the PCB 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 for individual design engineers and small teams.
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 Valor Division offers a line of products for DFM and manufacturing execution systems (MES). 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 three-dimensional 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 physical prototypes are built. This product line also includes the FloMasterTM one-dimensional computational fluid dynamics analysis software, which is used by thermo-fluid system engineers to model and analyze the fluid mechanics and pipe flow in complex systems. Finally, we offer the MicReD® T3Ster® advanced transient temperature measurement system, which enables thermal testing and characterization of electronics components, PCBs, and sub-systems, and the MicReD® Power Tester™ 1500A, which tests the reliability of electronic power components increasingly used in industries such as automotive and transportation, including hybrid and electrical vehicles and trains, and renewable energy applications such as wind turbines.


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New and Emerging Products
We provide specialized software tools for the design, analysis, and documentation of the complex electrical systems found in automotive, aerospace, and other transportation platforms. Electronic features constitute an increasingly high proportion of the value of automobiles and airplanes. These tools also support the design, costing, and manufacturing process modeling of wire harnesses.

Our Embedded Systems Division provides runtime software, customizable reference hardware, design tools, and professional engineering services that enable our customers to build secure embedded systems utilizing heterogeneous multi-core and multi-operating system platforms. Our embedded software solutions are used in automotive, industrial, mobile, medical, aerospace, IoT and consumer electronics markets. Our automotive solutions are used in advanced driver assistance systems, autonomous drive, telematics, automotive networking, and driver information, where we supply commercial Linux platforms for in-vehicle-infotainment.

Services and Other
Mentor Consulting, our professional services division, is comprised of a worldwide team of consulting professionals. We provide services such as business process design, methodology development, enterprise integration, and large scale deployment. These services accelerate the deployment and adoption of Mentor Graphics’ technologies to help our customers improve their cost, quality, and time to market. The services provided to customers are concentrated around our Calibre, Questa, Veloce, Tessent, Xpedition, and system design products.

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 62% of total revenues for fiscal year 2017, 57% for fiscal year 2016, and 55% for fiscal year 2015. We enter into foreign currency exchange contracts in an effort to mitigate the impact of foreign currency fluctuations. See “ Revenues by Geography” 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.

We are not dependent on any single customer and no single customer accounted for more than 10% of our consolidated net revenues during any of the last three fiscal years. 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 customers. At some point during the selling cycle, our products may also be loaned to customers for on-site evaluation. We primarily ship our software products to customers 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 $89 million as of January 31, 2017 compared to $109 million as of January 31, 2016. This backlog includes software products and emulation hardware systems requested for delivery within six months, and professional services and training requested for delivery within one year. We do not track backlog for support services. The January 31, 2017 backlog of orders is expected to be delivered before the end of our fiscal year ending January 31, 2018.

MANUFACTURING OPERATIONS
Our software manufacturing operations primarily consist of reproduction of our technical software, printing of documentation, and assembly. Mentor Graphics (Ireland) Limited, our wholly owned subsidiary, either manufactures or contracts with third-parties to manufacture our products and distributes these tangible 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.)

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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
Our research and development is focused on continued improvement of our existing products and the development of new products. During the fiscal year ended January 31, 2017 we expensed $412 million related to product research and development compared to $381 million for fiscal years 2016 and 2015. We also seek to expand existing product offerings and pursue new lines of business through acquisitions. During the fiscal years ended January 31, 2017, 2016 and 2015, we amortized purchased technology of $7 million. Our future success depends on our ability to develop or acquire competitive new products that satisfy customer requirements.

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 and hardware, 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 capabilities, depth of key personnel, or technological knowledge to compete successfully in our markets.

EMPLOYEES
We employed approximately 5,968 people full time as of January 31, 2017. 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 approximately 1,200 patents on inventions embodied in our products or that are otherwise relevant to EDA technology. In addition, we have approximately 250 patent applications pending in the U.S. and elsewhere. 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 IP 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.
 

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Item 1A.
Risk Factors.
The forward-looking statements contained in this report that are not statements of historical fact including without limitation statements containing the words “believes,” “expects,” “projections,” and words of similar meaning, constitute forward-looking statements that involve a number of risks and uncertainties that are difficult to predict. Moreover, from time to time, we may issue other forward-looking statements. Forward-looking statements regarding financial performance in future periods, 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.

The announcement and pendency of our agreement to be acquired by United States-based entities affiliated with Siemens AG could adversely affect our business.
On November 14, 2016, we announced that we had entered into a definitive agreement for the Company to be acquired by United States (U.S.)-based entities affiliated with Siemens AG (“Siemens”). Uncertainty about the effect of the proposed transaction on our customers, employees and other parties may adversely affect our business. Customers may refrain from doing business with us or delay placing orders because of uncertainty, which could adversely affect our business, results of operations and financial condition. Our employees may experience uncertainty about their roles or seniority following the transaction. There can be no assurance that our employees, including key personnel, can be retained to the same extent that we have previously been able to attract and retain employees. Any loss or distraction of such employees could adversely affect our business and operations. In addition, we have diverted, and will continue to divert, significant management resources toward the completion of the transaction, which could adversely affect our business and operations. Parties with which we do business may experience uncertainty associated with the transaction and related transactions, including with respect to current or future business relationships with us.

The failure to complete the sale to entities affiliated with Siemens could adversely affect our business.
Completion of the Company's sale to Siemens is subject to conditions, which may or may not be within our control, that may prevent, delay, or otherwise adversely affect its completion. The consummation of the transaction is conditioned on (1) receipt of certain regulatory approvals, including certain foreign antitrust laws, as well as the Committee on Foreign Investment in the U.S.; (2) the accuracy of the representations and warranties and our compliance with the covenants contained in the definitive agreement; and (3) other customary conditions. If any of these conditions are not satisfied or waived, it is possible that the transaction will not be consummated in the expected time frame or that the definitive agreement may be terminated. If the proposed sale or a similar transaction is not completed, the share price of our common stock will drop to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. In addition, under circumstances defined in the definitive agreement, we may be required to pay a termination fee of $134.45 million to Siemens. Further, a failed transaction may result in negative publicity and a negative impression of us in the investment community. Finally, any disruption to our business resulting from the announcement and pendency of the transaction and from intensifying competition from our competitors, including any adverse changes in our relationships with our customers, employees and other parties, could continue or accelerate in the event of a failed transaction. There can be no assurance that our business, these relationships or our financial condition will not be adversely affected, as compared to the condition prior to the announcement of the transaction, if the transaction is not consummated.

While the acquisition by Siemens is pending, we are subject to business uncertainties and contractual restrictions that could harm our operations and the future of our business or result in a loss of employees.
The definitive agreement for our acquisition includes restrictions on the conduct of our business prior to the completion of the transaction, generally requiring us to conduct our businesses in the ordinary course, consistent with past practice, and subjecting us to a variety of specified limitations unless we obtain Siemens’s prior written consent. We may find that these and other contractual arrangements in the definitive agreement may delay, prevent or limit us from responding effectively to competitive pressures, industry developments and future business opportunities that may arise during such period, even if our management and board of directors think that they may be advisable. In connection with the pending transaction, it is possible that some customers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationship with us as a result of the transaction. In addition, whether or not the transaction is completed, while it is pending we will continue to incur costs, fees, expenses and charges related to the proposed transaction, which may materially and adversely affect our business results and financial condition.


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Weakness in the United States and international economies may harm our business.
Our revenue levels are generally dependent on the level of technology capital spending, which includes worldwide expenditures for electronic design automation (EDA) software, hardware, and consulting services. Periods of economic uncertainty arising out of concerns such as weakness in the European Union relating to debt issues or political instability, slowing growth in China, and the continuing weakness of the Japanese economy may adversely affect our customers. In addition, a significant consolidation has been occurring in the semiconductor industry worldwide. As a result, customers may postpone decisions to license or purchase our products, reduce their spending, or be less able or willing to fulfill payment obligations, any of which could adversely affect our business. In addition, significant customer payment defaults or bankruptcies could materially harm our business.

We are subject to the cyclical nature of the integrated circuit and electronics systems industries.
Purchases of our products and services are highly dependent upon new design projects initiated by customers in the integrated circuit (IC) and electronics systems industries. These industries are highly cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. The increasing complexity of ICs and resulting increase in costs to design and manufacture ICs have in recent years led to fewer design starts, which could reduce 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 business could be negatively impacted as a result of merger and acquisition activity by our customers.
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. Merger and acquisition activity in the semiconductor industry was unusually strong during 2015 and remained strong through the first half of 2016. This activity appears to be the result of semiconductor companies, experiencing slower sales in their existing market segments, desiring to broaden the scope of their businesses and to spread the rising costs of product development and use of advanced technologies across a larger organization. Increasing consolidation could result in fewer customers in these 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.

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 postpone negotiating the terms of a transaction until the end of a fiscal quarter anticipating they will 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, products, and services 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 own and investors’ expectations, which could have a material adverse impact on our business.


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Our revenues are also affected by the mix of transaction types in which 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 not meeting our near-term revenue expectations.

The gross margin on our software is greater than that for our 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 engage in predatory pricing. These practices could significantly reduce demand for our products or limit our pricing.

We currently compete primarily with two large companies: Synopsys, Inc. (Synopsys) and Cadence Design Systems, Inc. (Cadence). We also compete with smaller companies with focused product portfolios and manufacturers of electronic devices and semiconductor equipment that have acquired or internally developed their own EDA products.

Emulation technology is complex and difficult to develop; inaccurate forecasts of customer demand for existing and new emulation products may adversely affect our results.
Designing, developing, and introducing new emulation products is a complicated process. The development process for our emulation products requires a high level of innovation. After the development phase, we must be able to forecast customer demand and manufacture next generation products with features, capacity and performance desired by customers in sufficient volumes to meet this demand in a cost effective manner. Our manufacturing model, in which our emulation products generally are not built until after customer orders have been forecast, may from time to time experience delays in delivering products to customers in a timely manner. These delays could cause our customers to purchase emulation products from our competitors. Customers may also delay purchases of existing products in anticipation of our next generation product releases or those of our competitors. We may be unable to minimize this impact by anticipating and managing the addition of, and transition to, new generations of emulation hardware. Conversely, if we manufacture emulation products in anticipation of future sales which do not timely occur, we may hold excess inventory with associated risks of product obsolescence.

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 (PCBs); 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. Natural disasters such as weather or earthquakes may adversely affect the supply of components, sub-assemblies or shipment of final products.

Foreign currency fluctuations may have an adverse impact on our operating results.
We typically generate more than half of our revenues from customers outside the U.S. and we generate approximately 40% of our expenses outside the U.S. While most of our international sales are denominated in U.S. dollars, our international operating expenses are typically denominated in foreign currencies. Significant changes in currency exchange rates, particularly in the Japanese yen and the euro, could have an adverse impact on our operating results.


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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 receivable collection periods; issues relating to complying with complex customs regulations and paying customs duties and value added taxes; changes in a specific country’s or region’s economic or political conditions; trade protection measures; trade sanctions, such as those imposed on Russia by the U.S. and the European Union; local labor laws; import or export licensing requirements; anti-corruption, anti-bribery, and other similar laws; loss or modification of exemptions for taxes and tariffs; limitations on repatriation of earnings; and difficulties with licensing and protecting our intellectual property (IP) rights. If we violate laws related to our business, we could be subject to penalties, fines, or other sanctions and could be prohibited or restricted from doing business in one or more countries.

Integrated circuit, printed circuit board and systems technology evolves rapidly.
The complexity of ICs, PCBs, and electrical systems continues to rapidly increase. In response to this increasing complexity, new design tools and methodologies must be invented or acquired quickly to remain competitive. If we fail to quickly respond to new technological developments, our products could become obsolete or uncompetitive, which could materially adversely impact our business.

We may have to replace emulation components under warranty or under support contracts.
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 or as part of our customer support obligations, thus increasing our costs and reducing availability of components for other sales.

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 may not operate as expected. Errors or defects could result in:
Loss of current customers and 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.
Our products have long sales cycles. 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. Purchases of our products and services are sometimes discretionary and may be delayed if customers postpone 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

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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, our business could be materially adversely impacted.

Conflict minerals regulations may adversely impact our ability to conduct our business.
The Securities and Exchange Commission (SEC) has adopted disclosure rules for companies that use conflict minerals (commonly referred to as tantalum, tin, tungsten, and gold) in their products, with substantial supply chain verification requirements if the materials come from, or could have come from, the Democratic Republic of the Congo or adjoining countries. These requirements could affect the sourcing, availability, and pricing of materials used in our hardware products as well as the companies we use to manufacture our products and their components. As a result, there may only be a limited pool of suppliers who provide conflict-free metals, and we cannot provide assurance that we will be able to obtain products in sufficient quantities or at competitive prices. The costs of complying with these rules could adversely affect our current or future business.

Pre-announcing products may adversely impact current sales.
We or our competitors sometimes pre-announce or provide “road maps” of the expected availability of new hardware or software products or product features. Such pre-announcements, whether offered by the pre-announcing company or its competitors, can result in customers canceling or deferring orders for currently offered products anticipating that currently offered products may be uncompetitive or lacking in features or performance. In the case of hardware products, slowing sales may cause inventories to increase or become obsolete, resulting in the need to discount or reduce production of current products.

We derive a substantial portion of our revenues from relatively few product groups.
We derive a substantial portion of our revenues from sales of relatively few product groups and related support services. As a result, any factor adversely affecting sales of these products, including product release cycles, market acceptance, product competition, performance and reliability, reputation, price competition, and economic and market conditions, could harm our operating results.

Accounting rules governing revenue recognition are complex and periodically change.
The accounting rules governing revenue recognition are complex and are revised periodically. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes nearly all existing revenue recognition guidance under U.S. generally accepted accounting principles (GAAP). This rule is based on the principle that the amount of revenue recognized should reflect the consideration an entity expects to receive for goods and services provided to customers. The rule defines a five step process for revenue recognition, making it possible for more judgment and estimation within the revenue recognition process than is required under existing U.S. GAAP. Currently, we will be required to implement this guidance in the first quarter of fiscal year 2019. The standard permits the use of either a retrospective or cumulative effect transition method. We have not yet selected a transition method, nor have we determined the effect of the standard on our ongoing financial reporting. Implementation of this new standard could have a significant effect on our reported financial results.

We may have additional tax liabilities.
Significant judgments and estimates are required in determining the provision for income taxes including the determination of research and development incentives and other credits 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 successfully challenged by tax authorities. The application of transfer pricing involves subjectivity, with a variety of application between countries. Transfer pricing disputes are especially common in certain countries, and on specific types of transactions such as business and IP transfers and management fees, and are increasingly resulting in litigation. Additionally, our tax expense could be impacted by the applicability of withholding taxes on software licenses, services, and related intercompany transactions in certain jurisdictions. Furthermore, our tax expense could be impacted if a tax authority successfully asserted that we, or one of our subsidiaries, has a taxable presence in a country where that member of our group is not currently filing. Increasingly, tax authorities are asserting that foreign companies have unreported taxable presences, and various authorities are either evaluating or adjusting their laws and practices to lower the threshold for a taxable presence in conjunction with the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Project.

In determining the adequacy of income taxes, we assess the likelihood of adverse outcomes that could result if our tax positions were challenged by the Internal Revenue Service (IRS) and other local or foreign tax authorities. The tax authorities in many of

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the countries where we do business regularly examine our income and other tax returns, and the ultimate outcome of these tax audits or other examinations cannot be predicted with certainty.

U.S. income taxes and foreign withholding taxes have not been provided for on undistributed earnings of certain of our non-U.S. subsidiaries to the extent that such earnings are considered to be indefinitely reinvested in the operations of those subsidiaries. A change in our decision concerning the amount of historical foreign earnings not considered indefinitely reinvested could increase our effective tax rate.

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. GAAP. Income tax expense (benefit) for interim quarters is based on a forecast of our global tax rate, including a separate determination for entities, if any, with losses for which no tax benefit is obtained. This forecast contains numerous assumptions and includes forward looking financial projections, such as the expectations of profit and loss by jurisdiction. 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 in the timing of repatriations of non-permanently reinvested 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 from our forecast.

Certain tax policy efforts, including the OECD’s BEPS Project, the European Commission’s state aid investigations, and other initiatives could have a material effect on the taxation of international businesses, particularly companies with global IP and supply chain structures, and companies which publish software. Furthermore, many of the countries where we are subject to taxes, including the U.S., are independently evaluating their tax policies and we may see significant changes in legislation and regulations concerning taxation. Certain countries have already enacted legislation which could affect international businesses, and other countries have become more aggressive in their approach to audits and enforcement of their applicable tax laws. Such changes, to the extent they are brought into tax legislation, regulations, policies, or practices, could increase our effective tax rates in various countries where we have operations and our overall tax rate could be materially affected, impacting our operating results, cash flows and financial condition.

There are limitations on the effectiveness of controls.
We do not expect that disclosure controls or internal control over financial reporting will prevent all errors and all fraud or that our policies and procedures can prevent all violations of the law by our employees, contractors, or agents. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that our control system will detect all errors and instances of fraud, if any, or prevent our employees, contractors, or agents from breaching or circumventing our policies or violating laws and regulations. Failure of our control systems to prevent error and fraud or violations of the law could materially adversely impact us.

We are subject to changing corporate governance regulations that impact compliance costs and risks of noncompliance.
Rules and regulations set out by various governmental and self-regulatory organizations in the U.S. such as the SEC, NASDAQ, the Financial Industry Regulatory Authority, and the FASB, 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 products. Research and development activities are often performed over long periods of time. These efforts may not result in successful product offerings because of changes in market conditions, competitive product offerings, advancements in technology 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.


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We may acquire other companies and may not successfully integrate them.
We have acquired numerous businesses and are frequently in discussions with potential acquisition candidates, and we may acquire other businesses in the future. While we generally analyze potential transactions before committing to them, we cannot provide assurance 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:
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 and services 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. A competitor 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 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. Similarly, our competitors may purchase companies or technology on which we have a dependency resulting from our having bundled the acquired software with our products for licensing to customers or our use of the acquired software in our research and development environment.

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 of non-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 have a history of successfully collecting under the original payment terms of fixed-term license agreements 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, U.S. GAAP would require revenue to be recognized as the payments become due and payable over the license term. This change could have a material adverse impact on our near-term results.

We may not adequately protect our proprietary rights or we may fail to obtain software or other intellectual property licenses.
Our success depends, in large part, upon our proprietary technology. We generally rely on patents, copyrights, trademarks, trade secret laws, licenses, and restrictive agreements to establish and protect our proprietary rights in technology and products. Despite precautions we take to protect our IP, we cannot provide assurance that third parties will not challenge, invalidate, or circumvent these protections. The companies in the EDA industry, as well as entities and persons outside the industry, continue to obtain patents at a rapid rate. We cannot predict if any of these patents will cover any of our products. In addition, many of

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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 provide assurance that the rights granted under our patents will provide us with a 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. In addition, recent U.S. court decisions have weakened the enforceability of patents for software-related inventions, which make up a large portion of our patent portfolio. 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 the actions we take to limit piracy, other parties regularly illegally copy and use our products, which results in lost revenue.

Some of our products include software or other IP licensed from third parties, and we may have to seek new licenses or renew existing licenses for software and other IP in the future. Failure to obtain software or other IP licenses or rights from third parties on favorable terms could materially adversely impact us.

Alice court ruling could have a negative effect on the validity of some of our U.S. patents.
On June 19, 2014, the U.S. Supreme Court issued a significant decision in Alice Corp. Pty. Ltd. v. CLS Bank Int'l, in which the Court tightened the standard for patentability of software inventions. The Court stated that if a person has an idea so abstract that it cannot be patented, simply tying it to a “generic computer cannot transform a patent-ineligible abstract idea into a patent-eligible invention.” Many commentators believe the Alice decision is another in a line of cases intended to limit the use of poor quality software patents. In any event, the Alice decision will provide accused infringers of software patents new arguments to challenge the validity of such patents. At this time, the effects of the Alice decision are still being assessed by patent holders, attorneys, the U.S. Patent and Trademark Office and courts. The Alice decision and related U.S. Supreme Court decisions could potentially have a negative effect on the validity of some of our U.S. patents.

Intellectual property infringement actions may harm our business.
Patent holders are making increasing efforts to monetize their patent portfolios. IP infringement claims against us directly, or where we contractually must defend our customers, could result in costly litigation and consume significant time of employees and management. In addition, IP litigation could harm our business, 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 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 provide assurance that we can continue to recruit and retain such personnel. Our failure to hire and retain such personnel could impair our ability to develop new products and manage our business effectively.

We have global sales and research and development offices in parts of the world that are not as politically stable as the United States.
We have global sales and research and development offices, some of which are in parts of the world that are not as politically stable as the U.S. In particular, approximately 15% of our workforce, and a larger percentage of our engineers, are located in our offices in Armenia, Egypt, Israel, Morocco, Pakistan, and Russia which are 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 adverse effect on product delivery and our research and development operations.


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Our business is subject to the risk of natural disasters.
We have sales and research and development offices worldwide which may be adversely affected by weather, earthquakes, or other natural disasters. If a natural disaster occurs at or near any of our offices, our operations may be interrupted, which could adversely impact our business and results of operations. In addition, if a natural disaster impacts a significant number of our customers, our business and results of operations could be adversely impacted.

If our information technology security measures are breached, our information systems may be perceived as being insecure, which could harm our business and reputation.
Our products and services involve the storage and transmission of proprietary information owned by us and our customers. We have sales and research and development offices throughout the world. Our operations are dependent upon the connectivity of our operations worldwide. Despite our security measures, our information technology and infrastructure may be vulnerable to breach by cyber-attacks, errors or malicious actions by employees or contractors, 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, lose existing customers or increase the difficulty of gaining new customers.

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, 2017, we had $289.9 million of outstanding indebtedness, which includes principal of $253.0 million of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures), $5.2 million in other notes payable, and $31.7 million in short-term borrowings. This level of indebtedness among other things could:
Make it difficult for us to satisfy 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, 2017 of $19.82 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 $23.78 per share as of January 31, 2017, for at least 20 of the last 30 trading days of the previous fiscal quarter. The 4.00% Debentures are currently convertible. If any of the holders elect to convert their debentures, we are 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

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4.00% Debentures elect to convert, we could have difficulty paying the amount due upon conversion, which would have a 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.

Ability to pay dividends.
We currently declare and pay quarterly cash dividends on our common stock. Any future payment of cash dividends will depend upon our financial condition, earnings, available cash, cash flow, and other factors our board of directors deems relevant. Our revolving credit facility contains certain financial and other covenants, including a limit on the aggregate amount we can pay for dividends and repurchases of our stock over the term of the facility of $200 million plus 70% of our cumulative net income (loss) for periods ending after February 1, 2016. In addition, our board may decrease or discontinue payment of dividends at any time, and payment of dividends will cease upon our acquisition by Siemens.


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Item 1B.
Unresolved Staff Comments.
None.
 
Item 2.
Properties.
We own seven buildings on 43 acres of land in Wilsonville, Oregon, occupying approximately 391,000 square feet in those buildings as our corporate headquarters. We also own an additional 65 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 four buildings totaling approximately 277,000 square feet in Fremont, California which house research and development, sales, and administrative staff. We own two buildings totaling approximately 46,000 square feet in Shannon, Ireland which house information technology and administrative staff.

We lease additional space in Longmont, Colorado; Arcadia, California; Kirkland, Washington; Huntsville and Mobile, Alabama; Novi, Michigan; and Marlborough 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, Canada, Chile, Egypt, France, Germany, Hungary, India, Israel, Morocco, Pakistan, Poland, Romania, 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 fiscal year ending January 31, 2018.
 
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 (IP) rights, contracts, distributorships, and employee relations matters. Periodically, we review the status of various disputes and litigation matters and assess our potential exposure. When we consider the potential loss from any dispute or legal matter probable and the amount or the range of loss can be estimated, we will accrue a liability for the estimated loss. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, we base accruals on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation matters and may revise estimates. We believe that the outcome of current litigation, individually and in the aggregate, will not have a material effect on our results of operations.

In some instances, we are unable to reasonably estimate any potential loss or range of loss. The nature and progression of litigation can make it difficult to predict the impact a particular lawsuit will have. There are many reasons why we cannot make these assessments, including, among others, one or more of the following: a proceeding being in its early stages; damages sought that are unspecific, unsupportable, unexplained or uncertain; discovery not having been started or being 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.

Synopsys, Inc., Emulation and Verification Engineering S.A. and EVE-USA, Inc.
In December 2012, Synopsys, Inc. (Synopsys) filed a lawsuit claiming patent infringement against us in the United States (U.S.) District Court for the Northern District of California, alleging that our Veloce® family of products infringed four Synopsys U.S. patents. In January 2015, the court issued a summary judgment order in our favor invalidating all asserted claims of three of the Synopsys patents. In June 2015, the U.S. Patent and Trademark Office ruled that claims of the remaining patent asserted against us by Synopsys are unpatentable. This case is no longer on the court’s docket for trial. Synopsys appealed the decisions by both the district court and the U.S. Patent and Trademark Office. The Court of Appeals for the Federal Circuit has unanimously confirmed the invalidity of all four Synopsys patents.

In June 2013, Synopsys also filed a claim against us in the U.S. District Court for the District of Oregon, similarly alleging that our Veloce family of products infringed two additional Synopsys U.S. patents.

We believe these lawsuits were filed in response to patent lawsuits we filed in 2010 and 2012 in the U.S. District Court for the District of Oregon against Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), which Synopsys acquired in October 2012. We alleged in our lawsuits that EVE (and later Synopsys) infringed five Mentor Graphics' patents.

Both of Synopsys' patents and four of our patents were removed from the Oregon case on summary judgment, and we proceeded to trial on our one remaining patent - U.S, Patent No. 6,240,376 (the '376 Patent). On October 10, 2014, a jury found that EVE and Synopsys infringed the '376 Patent. As part of the verdict, the jury awarded us damages of approximately $36

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million. As of January 31, 2017 nothing has been included in our financial results for this award. On March 12, 2015, the Oregon court granted our request for a permanent injunction against future sales of Synopsys emulators containing the infringing technology.

Synopsys filed an appeal, and sought to have the infringed claims invalidated by the U.S. Patent and Trademark Office.

On December 15, 2016, the U.S. Patent and Trademark Office dismissed Synopsys' challenge to the validity of claims 1 and 28 of the '376 Patent based on a prior proceeding. Synopsys' challenge to claims 24, 26, and 27 of the '376 Patent remains pending.

On March 16, 2017, the Federal Circuit issued its order on Synopsys' appeal, affirming the jury's finding of infringement and the $36 million damages award in our favor. The Court also found that the litigation could continue with three of our patents, and one Synopsys patent, that had been removed from the case on summary judgment. The Court further found that we could proceed with a claim of willful infringement, which can result in a trebled damages award. The Federal Circuit's decision enables us to proceed to trial on these claims in the U.S. District Court for the District of Oregon.

We do not have sufficient information upon which to determine that a loss in connection with these matters is probable, reasonably possible, or estimable, and thus no liability has been established nor has a range of loss been disclosed.

Securities Class Action and Shareholder Derivative Lawsuits
On March 18, 2016, a purported securities class action lawsuit, Haroutunian v. Mentor Graphics, was filed in the U.S. District Court for the District of Oregon against the Company and three executive officers alleging violations of federal securities laws. The lawsuit alleges that the Company and certain of our officers made material misstatements and omissions in press releases, Securities and Exchange Commission filings and analyst conference calls concerning the Company's business prospects and financial projections that artificially inflated the price of the Company’s stock. The lead plaintiff has been appointed and plaintiff's amended complaint was filed with the court on August 10, 2016. The Company and other defendants have moved to dismiss the amended complaint. A class of plaintiffs has not been certified by the court. The amended complaint does not request a specific amount of damages and we are unable to predict the outcome of this lawsuit.

On April 22, 2016, a related shareholder derivative lawsuit was filed in Multnomah County Circuit Court in Oregon, Aransu v. Rhines, against the Company's board of directors at the time, certain executive officers and the Company as a nominal defendant. The plaintiff filed an amended complaint on September 28, 2016. The amended complaint alleges that the directors and officers breached their fiduciary duties to the Company, were unjustly enriched, wasted corporate assets and committed insider selling. The shareholder derivative lawsuit generally alleges the same facts as the securities class action. The parties have agreed to stay proceedings in the Aransu lawsuit, pending the determination of certain issues or occurrence of certain events in the Haroutunian lawsuit. Because the complaint is derivative in nature, it does not seek monetary damages from the Company.

Item 4.
Mine Safety Disclosures.
Not applicable.


19


Part II
 
Item 5.
Market for 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 Year 2017
 
 
 
 
 
 
 
High Price
$
20.93

 
$
22.17

 
$
29.23

 
$
37.03

Low Price
$
16.18

 
$
19.05

 
$
20.83

 
$
28.22

Dividends Paid
$
0.055

 
$
0.055

 
$
0.055

 
$
0.055

Quarter ended
April 30
 
July 31
 
October 31
 
January 31
Fiscal Year 2016
 
 
 
 
 
 
 
High Price
$
25.43

 
$
27.38

 
$
27.54

 
$
28.09

Low Price
$
22.72

 
$
23.42

 
$
21.94

 
$
16.10

Dividends Paid
$
0.055

 
$
0.055

 
$
0.055

 
$
0.055


As of March 15, 2017, we had 304 stockholders of record.

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 6. “Short-Term Borrowings” in Part II, Item 8. “Financial Statements and Supplementary Data.”


20


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.

performancegraph20170131.gif

Note: The stock price shown on the above graph is not necessarily indicative of future performance.
 
Period Ending
Company/Market/Peer Group
1/31/2012
 
1/31/2013
 
1/31/2014
 
1/31/2015
 
1/31/2016
 
1/31/2017
Mentor Graphics Corporation
$
100.00

 
$
123.50

 
$
151.46

 
$
169.07

 
$
129.07

 
$
276.84

NASDAQ Market Index
$
100.00

 
$
113.13

 
$
149.71

 
$
171.20

 
$
172.41

 
$
212.46

S&P Application Software Index
$
100.00

 
$
112.67

 
$
130.55

 
$
144.84

 
$
157.18

 
$
200.24

Philadelphia Semiconductor Index
$
100.00

 
$
102.67

 
$
134.06

 
$
169.39

 
$
162.12

 
$
254.39


The table below sets forth information regarding our repurchases of our common stock during the three months ended January 31, 2017:
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, 2016

 
$

 

 
$
90,000,045

December 1 - December 31, 2016

 

 

 
$
90,000,045

January 1 - January 31, 2017

 

 

 
$
90,000,045

Total

 
$

 

 
 

On June 12, 2014, we announced a share repurchase program approved by our Board of Directors, authorizing the repurchase of up to $200 million of our common stock over a 3-year period. The repurchase that occurred in February 2016 was a single transaction excluded from our share repurchase program.

21


Item 6.
Selected Financial Data.
In thousands, except percentages and per share data
Fiscal year ended January 31,
2017
 
2016
 
2015
 
2014
 
2013
Statement of Income Data
 
 
 
 
 
 
 
 
 
Total revenues
$
1,282,467

 
$
1,180,988

 
$
1,244,133

 
$
1,156,373

 
$
1,088,727

Operating income
$
203,081

 
$
136,745

 
$
187,811

 
$
183,040

 
$
161,633

Net income attributable to Mentor Graphics shareholders
$
154,866

 
$
96,277

 
$
147,139

 
$
155,258

 
$
138,736

Gross profit percent
85
%
 
84
%
 
84
%
 
84
%
 
83
%
Operating income as a percent of revenues
16
%
 
12
%
 
15
%
 
16
%
 
15
%
Per Share Data
 
 
 
 
 
 
 
 
 
Net income per share attributable to Mentor Graphics shareholders (1):
 
 
 
 
 
 
 
 
 
Basic
$
1.42

 
$
0.83

 
$
1.28

 
$
1.33

 
$
1.20

Diluted
$
1.37

 
$
0.81

 
$
1.26

 
$
1.29

 
$
1.17

Weighted average number of shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
108,795

 
116,701

 
114,635

 
113,671

 
110,998

Diluted
114,322

 
119,263

 
117,078

 
116,702

 
114,017

Dividends paid
$
0.22

 
$
0.22

 
$
0.20

 
$
0.18

 
$

 
 
 
 
 
 
 
 
 
 
As of January 31,
2017
 
2016
 
2015
 
2014
 
2013
Balance Sheet Data
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, and short-term investments
$
441,087

 
$
334,826

 
$
230,281

 
$
297,312

 
$
223,783

Working capital
$
261,096

 
$
475,157

 
$
423,764

 
$
418,170

 
$
292,175

Property, plant, and equipment, net
$
210,680

 
$
182,092

 
$
170,737

 
$
160,165

 
$
162,402

Total assets
$
2,261,185

 
$
2,064,364

 
$
2,046,008

 
$
1,900,144

 
$
1,740,368

Short-term borrowings and current portion of notes payable
$
274,638

 
$
33,449

 
$
7,228

 
$
9,590

 
$
5,964

Long-term portion of notes payable, deferred revenue, long-term, and other noncurrent liabilities
$
112,711

 
$
320,625

 
$
318,252

 
$
288,384

 
$
282,366

Noncontrolling interest with redemption feature
$

 
$

 
$
13,372

 
$
15,479

 
$
12,698

Stockholders’ equity
$
1,375,683

 
$
1,320,429

 
$
1,272,854

 
$
1,185,294

 
$
1,033,479


(1) 
We have increased the numerator of our earnings per share calculation by $258 for the fiscal year ended January 31, 2016 and $121 for the fiscal year ended January 31, 2015 for the adjustment to decrease the noncontrolling interest with redemption feature to its calculated redemption value, recorded directly to retained earnings. We have decreased the numerator of our earnings per share calculation by $4,486 for the fiscal year ended January 31, 2014 and $5,272 for the fiscal 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.

22


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, multimedia, military and aerospace, 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, research and 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 additional purchases under existing contracts, to a lesser extent.

The EDA industry is competitive and is characterized by very strong leadership positions in specific segments of the EDA market. These strong leadership positions can be maintained for significant periods of time as the software can be difficult to master and customers are disinclined to make changes once their employees, as well as others in the industry, have developed familiarity with a particular software product. For these reasons, much of our profitability arises from areas in which we are the leader. We expect to continue our strategy of developing high quality tools with number one market share potential, rather than being a broad-line supplier with undifferentiated product offerings. This strategy allows us to focus investment in areas where customer needs are greatest and where we have the opportunity to build significant market share.

Our products and services are dependent to a large degree on new design projects initiated by customers in the integrated circuit (IC) and electronics system industries. These industries can be cyclical and are subject to constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, wide fluctuations in product supply and demand, and industry consolidation. Furthermore, extended economic downturns can result in reduced funding for

23


development due to downsizing and other business restructurings. These pressures are offset by the need for the development and introduction of next generation products once an economic recovery occurs.
KNOWN TRENDS AND UNCERTAINTIES IMPACTING FUTURE RESULTS OF OPERATIONS
Our revenue has historically fluctuated quarterly and has generally been the highest in the fourth quarter of our fiscal year due to our customers’ corporate calendar year-end spending trends and the timing of contract renewals.

Ten accounts make up approximately 45% 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 (net of cash based revenue invoices), and continue to experience no difficulty in factoring our high quality receivables.

Bad debt expense recorded for the fiscal year ended January 31, 2017 was not material. However, we do have exposures within our receivables portfolio to customers with weak credit ratings. These receivable balances could have a material adverse effect on earnings in any given quarter, should significant additional allowances for doubtful accounts be necessary. However, as discussed in Note 5. “Term Receivables and Trade Accounts Receivable” in Part II, Item 8. “Financial Statements and Supplementary Data”, we regularly evaluate the collectibility of our trade accounts receivable and record specific and general reserves for bad debt as necessary.

Bookings during fiscal year 2017 increased approximately 15% compared to fiscal year 2016 primarily due to the timing of contract renewals and additional business with existing customers. 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 emulation hardware systems, and within twelve months for professional services and training. Ten customers accounted for approximately 35% of total bookings for fiscal year 2017 compared to 40% for fiscal year 2016. The number of new customers for fiscal year 2017 was flat compared to fiscal year 2016.

PRODUCT DEVELOPMENT
During the fiscal year ended January 31, 2017, 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 fiscal year ended January 31, 2017, we introduced both 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 ongoing 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 revenues, costs, and expenses that are not readily apparent from other sources. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.

We believe that the accounting for revenue recognition, valuation of trade accounts receivable, income taxes, business combinations, goodwill, intangible assets, and 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 the discussion in “Critical Accounting Estimates” in Note 2. “Summary of Significant Accounting Policies” in Part II, Item 8. “Financial Statements and Supplementary Data.”


24


RESULTS OF OPERATIONS
Revenues and Gross Profit
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
System and software revenues
$
794.5

 
13
%
 
$
700.6

 
(12
)%
 
$
799.1

System and software gross profit
$
738.9

 
15
%
 
$
645.0

 
(11
)%
 
$
722.2

Gross profit percent
93
%
 
 
 
92
%
 
 
 
90
%
Service and support revenues
$
488.0

 
2
%
 
$
480.4

 
8
 %
 
$
445.0

Service and support gross profit
$
349.3

 
1
%
 
$
346.3

 
9
 %
 
$
317.6

Gross profit percent
72
%
 
 
 
72
%
 
 
 
71
%
Total revenues
$
1,282.5

 
9
%
 
$
1,181.0

 
(5
)%
 
$
1,244.1

Total gross profit
$
1,088.2

 
10
%
 
$
991.3

 
(5
)%
 
$
1,039.8

Gross profit percent
85
%
 
 
 
84
%
 
 
 
84
%

System and Software
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
Upfront license revenues
$
682.4

 
17
 %
 
$
582.0

 
(17
)%
 
$
704.8

Ratable license revenues
112.1

 
(5
)%
 
118.6

 
26
 %
 
94.3

Total system and software revenues
$
794.5

 
13
 %
 
$
700.6

 
(12
)%
 
$
799.1


We derive system and software revenues from the sale of licenses of software products and emulation hardware systems, including finance fee revenues from our long-term installment receivables resulting from term product sales. Upfront license revenues consist of perpetual licenses and term licenses for which we recognize revenue upon product delivery at the start of a license term. We identify licenses where collectibility is not probable and recognize revenue on those licenses when cash is received. Ratable license revenues primarily consist of short-term term licenses and finance fees from the accretion of the discount on long-term installment receivables.

Ten customers accounted for approximately 35% of system and software revenues for fiscal year 2017, 45% of system and software revenues for fiscal year 2016 and 40% of system and software revenues for fiscal year 2015. No single customer accounted for 10% of total revenues for fiscal years 2017, 2016, and 2015.

System and software revenues increased $93.9 in fiscal year 2017 compared to fiscal year 2016 primarily due to an increase in software license revenues driven by the timing of contract renewals and additional business with existing customers.

System and software revenues decreased $98.5 in fiscal year 2016 compared to fiscal year 2015. The effect of acquisitions completed in fiscal years 2016 and 2015 on fiscal year 2016 system and software revenues was $7.3. The decrease in system and software revenues was driven by a decrease in software license revenues of approximately $45.0 primarily due to a decrease in the growth percentage of contract renewals during the period. The remaining decrease was primarily due to a decrease in sales of emulation hardware systems.

System and software gross profit percentage was higher for fiscal year 2017 compared to fiscal year 2016 and for fiscal year 2016 compared to fiscal year 2015 primarily due to a more favorable product mix.

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 lower margin offerings which are staffed according to fluctuations in demand. Support services operate under a less variable cost structure.

Service and support revenues increased $7.6 in fiscal year 2017 compared to fiscal year 2016. The effect of acquisitions completed in fiscal years 2017 and 2016 on fiscal year 2017 service and support revenues resulted in a $10.1 decrease in service and support revenues from acquisitions compared to fiscal year 2016. This decrease was offset by a $10.7 increase in consulting and training revenues due to increased customer demand for services and a $6.5 increase in support revenues resulting from an increase in our installed base.


25


Service and support revenues increased $35.4 in fiscal year 2016 compared to fiscal year 2015. The effect of acquisitions completed in fiscal years 2016 and 2015 on fiscal year 2016 service and support revenues was $11.3. The remaining increase was primarily driven by increased support revenues resulting from an increase in our installed base.

Revenues Information
Revenues by Geography
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
North America
$
490.1

 
(3
)%
 
$
503.2

 
(10
)%
 
$
559.0

Europe
287.4

 
13
 %
 
254.8

 
 %
 
255.9

Japan
119.8

 
37
 %
 
87.2

 
(1
)%
 
87.7

Pacific Rim
385.2

 
15
 %
 
335.8

 
(2
)%
 
341.5

Total revenues
$
1,282.5

 
9
 %
 
$
1,181.0

 
(5
)%
 
$
1,244.1


The increase in revenues in Europe, Japan and Pacific Rim for fiscal year 2017 compared to fiscal year 2016 is due to the timing of contract renewals. The decrease in revenues in North America for fiscal year 2016 compared to fiscal year 2015 is due to decreased sales of emulation hardware systems and a decrease in the growth percentage of contract renewals during the period.

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 2017, approximately 30% of European and approximately 90% of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. For fiscal year 2016, approximately 30% of European and approximately 75% of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. For fiscal year 2015, approximately 25% of European and approximately 75% of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies.

Foreign currency had an immaterial impact on revenues for fiscal year 2017 compared to fiscal year 2016. Foreign currency had an unfavorable impact of $21.1 for fiscal year 2016 compared to fiscal year 2015 primarily as a result of the strengthening of the U.S. dollar against euro and Japanese yen.

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.”

Revenues 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%):
Fiscal year ended January 31,
2017
 
2016
 
2015
Revenues:
 
 
 
 
 
IC Design to Silicon
40
%
 
40
%
 
40
%
Scalable Verification
20
%
 
25
%
 
25
%
Integrated System Design
20
%
 
20
%
 
20
%
New and Emerging Markets
10
%
 
5
%
 
5
%
Services and Other
10
%
 
10
%
 
10
%
Total revenues
100
%
 
100
%
 
100
%

As described in Note 2. “Summary of Significant Accounting Policies,” term license arrangements may allow a customer to remix product usage from a fixed list of products at regular intervals during the license term. As a result, actual usage of our products by customers could differ, which could result in the percentages presented above being different.


26


Operating Expenses
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
Research and development
$
412.3

 
8
 %
 
$
381.4

 
 %
 
$
381.1

Marketing and selling
369.1

 
5
 %
 
351.3

 
(4
)%
 
365.7

General and administration
85.4

 
16
 %
 
73.9

 
(7
)%
 
79.2

Equity in earnings of Frontline
(3.4
)
 
(41
)%
 
(5.8
)
 
2
 %
 
(5.7
)
Amortization of intangible assets
6.0

 
(31
)%
 
8.7

 
6
 %
 
8.2

Special charges
15.8

 
(65
)%
 
45.1

 
92
 %
 
23.5

Total operating expenses
$
885.2

 
4
 %
 
$
854.6

 
 %
 
$
852.0


Selected Operating Expenses as a Percentage of Total Revenues
Fiscal year ended January 31,
2017
 
2016
 
2015
Research and development
32
%
 
32
%
 
31
%
Marketing and selling
29
%
 
30
%
 
29
%
General and administration
7
%
 
6
%
 
6
%
Total selected operating expenses
68
%
 
68
%
 
66
%

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 year 2017 compared to fiscal year 2016, we experienced favorable currency movements of $6.4 in total operating expenses, primarily due to movements in the Great British pound, Egyptian pound and Indian rupee. For fiscal year 2016 compared to fiscal year 2015, we experienced favorable currency movements of $36.5 in total operating expenses, primarily due to movements in the euro, Russian ruble, Japanese yen and Great British pound. The impact of these currency effects is reflected in the movements in operating expenses detailed below.

Research and Development
Research and development expenses increased by $30.9 for fiscal year 2017 compared to fiscal year 2016 and increased by $0.3 for fiscal year 2016 compared to fiscal year 2015. The components of these changes are summarized as follows:
 
Change
Fiscal year ended January 31,
2017 vs 2016
 
2016 vs 2015
Salaries, incentive compensation, and benefits expenses
$
24.8

 
$
(9.2
)
Supplies and equipment
3.5

 
2.5

Expenses associated with acquired businesses
2.8

 
8.1

Stock-based compensation
2.0

 
2.2

Outside services
(1.8
)
 
(1.3
)
Other expenses
(0.4
)
 
(2.0
)
Total change in research and development expenses
$
30.9

 
$
0.3



27


Marketing and Selling
Marketing and selling expenses increased by $17.8 for fiscal year 2017 compared to fiscal year 2016 and decreased by $14.4 for fiscal year 2016 compared to fiscal year 2015. The components of these changes are summarized as follows:
 
Change
Fiscal year ended January 31,
2017 vs 2016
 
2016 vs 2015
Salaries, incentive compensation, and benefits expenses
$
28.0

 
$
(23.8
)
Stock compensation
2.7

 
0.5

Expenses associated with acquired businesses
1.1

 
3.3

Emulation demonstration inventory amortization
(7.3
)
 
7.4

Outside services
(1.4
)
 
0.8

Other expenses
(5.3
)
 
(2.6
)
Total change in marketing and selling expenses
$
17.8

 
$
(14.4
)

General and Administration
General and administration expenses increased by $11.5 for fiscal year 2017 compared to fiscal year 2016 and decreased by $5.3 for fiscal year 2016 compared to fiscal year 2015. The components of these changes are summarized as follows:
 
Change
Fiscal year ended January 31,
2017 vs 2016
 
2016 vs 2015
Salaries, incentive compensation, and benefits expenses
$
11.5

 
$
(6.4
)
Outside services
1.8

 
(1.5
)
Stock-based compensation
1.2

 
1.7

Other expenses
(3.0
)
 
0.9

Total change in general and administration expenses
$
11.5

 
$
(5.3
)

Special Charges
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
Employee severance and related costs
$
6.8

 
(50
)%
 
$
13.5

 
286
 %
 
$
3.5

Merger costs
5.5

 
 %
 

 
 %
 

Litigation costs
1.5

 
(63
)%
 
4.1

 
(78
)%
 
18.4

Other costs, net
2.0

 
(13
)%
 
2.3

 
44
 %
 
1.6

Voluntary early retirement program

 
(100
)%
 
25.2

 
 %
 

Total special charges
$
15.8

 
(65
)%
 
$
45.1

 
92
 %
 
$
23.5


Special charges include expenses incurred related to employee severance, certain litigation costs, mergers and acquisitions, excess facility costs, and asset related charges.

Employee severance and related costs include severance benefits and notice pay. 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 record the charge for estimated severance benefits in the quarter that the rebalance plan is approved.

Merger costs for fiscal year 2017 primarily consist of costs incurred related to advisory fees and legal costs associated with the potential merger with Siemens Industry, Inc. (Siemens) and Meadowlark Subsidiary Corporation, a wholly-owned subsidiary of Siemens.

Litigation costs consist of professional service fees for services rendered, related to patent litigation involving us, Emulation and Verification Engineering S.A. and EVE-USA, Inc. (together EVE), and Synopsys, Inc. regarding emulation technology.

We offered the voluntary early retirement program in North America during the three months ended April 30, 2015 in which 110 employees elected to participate. The costs presented here are for severance benefits.


28


Provision for Income Taxes
Fiscal year ended January 31,
2017
 
Change
 
2016
 
Change
 
2015
Income tax expense
$
30.0

 
21
%
 
$
24.8

 
10
%
 
$
22.6

Effective tax rate
16
%
 
 
 
21
%
 
 
 
6
%

In fiscal year 2017, our income before taxes of $184.9 consisted of $216.8 of pre-tax income in foreign jurisdictions and a pre-tax loss of $31.9 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.

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, the provision for U.S. taxes on undistributed earnings of foreign subsidiaries not deemed to be permanently invested, and the application of valuation allowances on deferred tax assets.

Our effective tax rate was 16% for fiscal year 2017. 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;
Recognition of net operating loss carryforwards, foreign tax credit carryforwards and research and experimentation credit carryforwards for which no tax benefit has been recognized in the U.S.; and
The application of tax incentives for research and development.

These differences are partially offset by:
Provision of U.S. income tax on non-permanently reinvested foreign subsidiary earnings to account for the impact of future repatriations;
Increase in reserves for uncertain tax positions; and
Withholding taxes.

The effective tax rate for fiscal year 2017 was lower than our effective tax rate for fiscal year 2016 primarily due to the benefit of the reduction of U.S. valuation allowance on deferred tax assets recorded in the adoption of Accounting Standards Update (ASU) 2016-09, Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting, and an increase in the proportion of foreign earnings in fiscal year 2017 over fiscal year 2016 that are permanently reinvested outside of the U.S. In contrast, the provision for income taxes increased by $5.2 in fiscal year 2017 compared to fiscal year 2016 primarily due to the overall increase in foreign earnings and the provision of U.S. tax on the significant portion of those earnings that are not permanently reinvested outside of the U.S.

Net deferred tax liabilities increased by $2.2 from January 31, 2016 to January 31, 2017. Gross deferred tax assets increased by $17.0 from January 31, 2016 to January 31, 2017, principally due to the creation of additional research and experimentation credits in the U.S. and the availability of additional foreign tax credits. There was an $8.7 increase in deferred tax liabilities from January 31, 2016 to January 31, 2017 and a valuation allowance increase of $10.5 from January 31, 2016 to January 31, 2017. The changes in both the deferred tax liabilities and the valuation allowance principally related to the amount, and prospective tax thereon, of current year foreign subsidiary earnings treated as not permanently reinvested.

The liability for income taxes associated with net uncertain tax positions was $28.9 as of January 31, 2017 and $19.3 as of January 31, 2016. As of January 31, 2017, within the liability, $5.4 was classified as a short-term liability 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 $23.5 of income tax associated with uncertain tax positions was classified as long-term, in income tax liability in our consolidated balance sheet. We expect uncertain tax positions of $28.9, if recognized, would favorably affect our effective tax rate.

RECENT ACCOUNTING PRONOUNCEMENTS
Information regarding applicable recent accounting pronouncements applicable is discussed in Note 3. “Recent Accounting Pronouncements ” in Part II, Item 8. “Financial Statements and Supplemental Data.”


29


LIQUIDITY AND CAPITAL RESOURCES
Our primary ongoing cash requirements are for product development, operating activities, capital expenditures, repurchases of common stock, dividends, debt service, and acquisition opportunities that may arise. Our primary sources of liquidity are cash generated from operations and borrowings on our revolving credit facility.

We currently have access to 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, 2017, we have cash totaling $313.9 held by our foreign subsidiaries. A significant portion of our cash held by our foreign subsidiaries is accessible without a significant cash tax cost as the repatriation of foreign earnings will be sheltered from U.S. federal tax by tax credits. To the extent our foreign earnings are not permanently reinvested, we have provided for the tax consequences that would ensue upon their repatriation. In the event funds which are treated as permanently reinvested are repatriated, we will be required to accrue and pay additional taxes to repatriate these funds.

On February 23, 2016 we paid an intercompany dividend from foreign subsidiaries of $150,000. As the earnings associated with these funds were not treated as permanently reinvested, any U.S. tax consequences had already been included in our tax provision in prior periods.

To date, we have experienced no loss or lack of access to our invested cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets.

At any point in time, we have significant balances in operating accounts that are with individual third-party financial institutions, which may exceed the Federal Deposit Insurance Corporation insurance limits or other regulatory insurance program limits. We monitor daily the cash balances in our operating accounts and adjust them as appropriate; however, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets.

We anticipate that the following will be sufficient to meet our working capital needs on a short-term (twelve months or less) and a long-term (more than twelve months) basis:
Current cash balances;
Anticipated cash flows from operating activities, including the effects of selling and financing customer term receivables;
Amounts available under existing revolving credit facilities; and
Other available financing sources, such as the issuance of debt or equity securities.

We have experienced no difficulties to date in raising debt. However, capital markets can be volatile, and we cannot assure that we will be able to raise debt or equity capital on acceptable terms, if at all.

Cash Flow Information
Fiscal year ended January 31,
2017
 
2016
Cash provided by operating activities
$
321.8

 
$
231.3

Cash used in investing activities
$
(72.0
)
 
$
(53.0
)
Cash used in financing activities
$
(145.3
)
 
$
(72.6
)

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.


30


Trade Accounts and Term Receivables
Our cash flows from operating activities are significantly influenced by the payment terms on our license agreements and by our sales of qualifying accounts receivable. Our customers’ inability to fulfill payment obligations could adversely affect our cash flow. We monitor our accounts receivable portfolio for customers with low or declining credit ratings and increase our collection efforts when necessary. Trade accounts and term receivables consisted of the following:
As of January 31,
2017
 
2016
Trade accounts receivable, net
$
512.6

 
$
493.2

Term receivables, short-term (included in trade accounts receivable on the balance sheet)
$
298.0

 
$
317.2

Term receivables, long-term
$
303.7

 
$
268.7

Average days sales outstanding, including the short-term portion of term receivables
97

 
132

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

 
47


The decrease in the average days sales outstanding, including and excluding the short-term portion of term receivables, as of January 31, 2017 was primarily due to an increase in revenues in the fourth quarter of fiscal year 2017 compared to the fourth quarter of fiscal year 2016.

Term receivables are attributable to multi-year term license sales agreements. We include amounts for term agreements that are due within one year in trade accounts receivable, net, on our balance sheet and balances that are due in more than one year in term receivables, long-term. We use term agreements as a standard business practice and have a history of successfully collecting under the original payment terms without making concessions on payments, products, or services. Total term receivables were $601.7 as of January 31, 2017 compared to $585.8 as of January 31, 2016.

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 $45.7 for fiscal year 2017 compared to $42.7 for fiscal year 2016. 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 year 2018.

Accrued Payroll and Related Liabilities
As of January 31,
2017
 
2016
Accrued payroll and related liabilities
$
116.5

 
$
73.4


The increase in accrued payroll and related liabilities as of January 31, 2017 compared to January 31, 2016 was primarily due to an increase in incentive compensation and commissions accrued for fiscal year 2017 compared to fiscal year 2016 related to increased operating income in fiscal year 2017.

Investing Activities
Cash used in investing activities for fiscal year 2017 primarily consisted of cash paid for capital expenditures and business acquisitions.

Expenditures for property, plant, and equipment were $60.3 for fiscal year 2017 compared to $43.3 for fiscal year 2016. The expenditures for property, plant, and equipment for fiscal year 2017 were primarily a result of spending on information technology and infrastructure improvements within facilities.

During fiscal year 2017, we had $11.8 of expenditures for acquisitions of businesses and equity interests, compared to $11.7 during fiscal year 2016. 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.

Financing Activities
For fiscal year 2017, cash used in financing activities consisted primarily of the repurchase of common stock, the payment of dividends, repayments on the revolving credit facility, and payments related to tax withholding on the vesting of share based awards partially offset by proceeds received from the employee stock purchase plans (ESPP) purchases and exercises of stock options.

31



During fiscal year 2017, we paid four quarterly dividends of $0.055 per share of outstanding common stock for a total of $23.8. On March 2, 2017 we announced a quarterly dividend of $0.055 per share of outstanding common stock, payable on March 30, 2017 to shareholders of record as of the close of business on March 14, 2017. 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.

We currently have a share repurchase program, approved by our Board of Directors, authorizing the repurchase of up to $200 million of our common stock. We did not repurchase any shares of common stock under the repurchase program during fiscal year 2017. During fiscal year 2016, we repurchased 4.5 shares of common stock for $85.0. As of January 31, 2017, $90.0 remains available for repurchase under the program. During fiscal year 2017, we repurchased 8.1 shares of common stock for $146.1 in a single transaction that was not part of our repurchase program.

The terms of our revolving credit facility limit the combination of the amount of our common stock we can repurchase and the amount of dividends we can pay over the term of the facility to $200.0 plus 70% of our cumulative consolidated net income (loss) for periods after February 1, 2016. An additional $138.5 is available for common stock repurchases or dividend payments under this limit as of January 31, 2017.

During fiscal year 2017 we paid $5.0 on our revolving line of credit. During fiscal year 2016 we received proceeds of $25.0 from our revolving credit facility.

Other Factors Affecting Liquidity and Capital Resources
4.00% Convertible Subordinated Debentures due 2031
In April 2011, we issued $253.0 of 4.00% Convertible Subordinated Debentures due 2031 (4.00% Debentures). Interest on the 4.00% Debentures is payable semi-annually in April and October.

Each one thousand dollars in principal amount of the 4.00% Debentures is currently convertible, under certain circumstances, into 50.4551 shares of our common stock (equivalent to a conversion price of $19.82 per share). The events that permit conversion are described in Note 7. “Notes Payable” in Part II, Item 8. “Financial Statements and Supplementary Data.”

Upon conversion of any 4.00% Debentures, a holder will receive:
(i)
Cash for the lesser of the principal amount of the 4.00% Debentures that are converted or the value of the converted shares; and
(ii)
Cash or shares of common stock, at our election, for the excess, if any, of the value of the converted shares over the principal amount.

If any one of the conversion events occurs, the 4.00% Debentures become convertible and the net balance of the 4.00% Debentures is classified as a current liability in our consolidated balance sheet. The classification of the 4.00% Debentures as current or long-term in the consolidated balance sheet is evaluated at each balance sheet date and may change from quarter to quarter depending on whether any of the conversion conditions are met.

During the fiscal quarter ended January 31, 2017, the market price of our common stock exceeded 120% of the conversion price for at least 20 of the last 30 trading days of the period. Accordingly, the 4.00% Debentures are convertible at the option of the holders through April 30, 2017. Therefore, the carrying value of the 4.00% Debentures is classified as a current liability. Additionally, the excess of the principal amount over the carrying amount of the 4.00% Debentures is reclassified from permanent equity to temporary equity in our consolidated balance sheet as of January 31, 2017. If the market price of our common stock does not exceed 120% of the conversion price for at least 20 of the last 30 trading days for the fiscal quarter ended April 30, 2017, the 4.00% Debentures will be reclassified as a long-term liability and the temporary equity will be reclassified to permanent equity in our consolidated balance sheet.

If all of the holders of the 4.00% Debentures elect to convert their debentures, we would be required to make cash payments of at least $253.0 prior to the maturity of the 4.00% Debentures.

We believe that current cash balances, cash generated from our operating activities in future periods, access to our revolving credit facility, and additional financing arrangements will be sufficient to service any conversion of the 4.00% Debentures; however, future changes in our cash position; cash flows from operating, investing and financing activities; general business levels; and our access to additional financing, may impact our ability to settle the amount payable to the holders of any 4.00% Debentures that are converted.

32



Effective April 5, 2016, we may redeem some or all of the 4.00% Debentures for cash 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 for cash on April 1, 2018, April 1, 2021, and April 1, 2026, and in the event of a fundamental change in the Company. In each case, the repurchase price will be 100% of the principal amount of the 4.00% Debentures plus any accrued and unpaid interest.

For further information on the 4.00% Debentures, see Note 7. “Notes Payable” in Part II, Item 8. “Financial Statements and Supplementary Data.”

Revolving Credit Facility
We have a syndicated, senior, unsecured, revolving credit facility with a maximum borrowing capacity of $125.0, which expires on January 9, 2020. Our interest rate on the facility is variable. Because the interest rate is variable, our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. Additionally, commitment fees can vary as they are payable on the unused portion of the revolving credit facility at rates between 0.30% and 0.40%.

We had borrowings of $20.0 against the revolving credit facility as of January 31, 2017 compared to $25.0 of borrowings as of January 31, 2016.

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, 2017. If we fail to comply with the financial covenants and do not obtain a waiver from our lenders, we would be in default under the revolving credit facility and our lenders could terminate the facility and demand immediate repayment of all outstanding loans under the revolving credit facility.

For further information on our revolving credit facility, see Note 6. “Short-Term Borrowings” in Part 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, 2017:
 
Payments due by period
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
More than 5
years
Notes payable (1)
$
258.1

 
$

 
$
5.1

 
$

 
$
253.0

Interest on debt
143.3

 
10.1

 
20.2

 
20.2

 
92.8

Other liabilities (2)
17.0

 
3.0

 
7.0

 
0.4

 
6.6

Other borrowings
31.7

 
31.7

 

 

 

Operating leases
98.7

 
22.1

 
38.2

 
24.5

 
13.9

Total contractual obligations
$
548.8

 
$
66.9

 
$
70.5

 
$
45.1

 
$
366.3

(1) 
The 4.00% Debentures are currently convertible at the option of the holders and the $253.0 principal balance would be due immediately if all of the 4.00% Debentures were converted.
(2) 
Our balance sheet as of January 31, 2017 includes additional long-term taxes payable of $26.7 related to uncertain income and other tax positions for which the timing of the ultimate resolution is uncertain. At this time, we are unable to make a

33


reasonably reliable estimate of the timing of any cash settlement with the respective 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.

OUTLOOK
On November 12, 2016, we entered into a definitive agreement to be acquired by Siemens Industry, Inc. (Siemens) and Meadowlark Subsidiary Corporation, a wholly-owned subsidiary of Siemens. As a result of the acquisition announcement, we will not provide an outlook for future financial results and have withdrawn all previously issued financial guidance.

34


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, 2017.
Principal (notional) amounts in United States dollars
Carrying Amount
 
Average Fixed Interest Rate
Money market funds
$
286.0

 
0.58%
Bank time deposits
71.3

 
0.91%
Total cash equivalents
$
357.3

 
0.64%

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, 2017 and January 31, 2016. Generally, interest rate changes for fixed rate debt affect the fair value of the debt but do not affect future earnings or cash flow.

We have a syndicated, senior, unsecured, revolving credit facility, which expires on January 9, 2020. Borrowings under the revolving credit facility are permitted to a maximum of $125.0. Our interest rate on the facility is variable, and our interest expense associated with borrowings under this revolving credit facility will vary with market interest rates. As of January 31, 2017 we had an outstanding balance of $20.0 against this revolving credit facility compared to $25.0 as of January 31, 2016. Generally, interest rate changes for variable interest rate debt do not affect fair value, but do affect future earnings and cash flow. For further information on our revolving credit facility, see Note 6. “Short-Term Borrowings” in Part II, Item 8. “Financial Statements and Supplementary Data.”

We had other short-term borrowings of $0.9 outstanding as of January 31, 2017 and January 31, 2016 with variable rates based on market indexes.


35


FOREIGN CURRENCY RISK
We transact business in various foreign currencies and have established a 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 that 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 denominated expenses over expected euro 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.

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,
2017
 
2016
 
Gross
Notional
Amount
 
Weighted
Average
Contract
Rate
 
Gross
Notional
Amount
 
Weighted
Average
Contract
Rate
Forward Contracts:
 
 
 
 
 
 
 
Euro
$
54.2

 
0.93

 
$
41.5

 
0.92

Japanese yen
53.3

 
113.38

 
28.6

 
118.09

Indian rupee
25.4

 
68.12

 
31.6

 
67.96

Israeli shekel
13.0

 
3.80

 
19.3

 
3.95

British pound
11.8

 
0.81

 
11.0

 
0.70

Korean won
5.8

 
1,166.81

 
10.0

 
1,214.17

Other(1)
29.6

 

 
31.3

 

Total forward contracts
$
193.1

 
 
 
$
173.3

 
 
 
(1) 
Other includes currencies which are the Canadian dollar, Chinese yuan, Armenian dram, Swiss franc, Polish zloty, Russian ruble, Norwegian krone, Taiwan dollar, Hungarian forint, Danish krone, Chilean peso, Swedish krona, Romanian new leu and Singapore dollar.


36


Item 8.
Financial Statements and Supplementary Data.
Mentor Graphics Corporation
Consolidated Statements of Income
Fiscal year ended January 31,
2017
 
2016
 
2015
In thousands, except per share data
 
 
 
 
 
Revenues:
 
 
 
 
 
System and software
$
794,450

 
$
700,621

 
$
799,151

Service and support
488,017

 
480,367

 
444,982

Total revenues
1,282,467

 
1,180,988

 
1,244,133

Cost of revenues:
 
 
 
 
 
System and software
48,249

 
48,330

 
69,811

Service and support
138,651

 
134,025

 
127,403

Amortization of purchased technology
7,328

 
7,303

 
7,099

Total cost of revenues
194,228

 
189,658

 
204,313

Gross profit
1,088,239

 
991,330

 
1,039,820

Operating expenses:
 
 
 
 
 
Research and development
412,309

 
381,440

 
381,125

Marketing and selling
369,125

 
351,344

 
365,688

General and administration
85,361

 
73,853

 
79,193

Equity in earnings of Frontline
(3,434
)
 
(5,849
)
 
(5,653
)
Amortization of intangible assets
6,028

 
8,716

 
8,166

Special charges
15,769

 
45,081

 
23,490

Total operating expenses
885,158

 
854,585

 
852,009

Operating income:
203,081

 
136,745

 
187,811

Other income (expense), net
2,249

 
1,612

 
(777
)
Interest expense
(20,474
)
 
(19,428
)
 
(19,276
)
Income before income tax
184,856

 
118,929

 
167,758

Income tax expense
29,990

 
24,753

 
22,581

Net income
154,866

 
94,176

 
145,177

Less: Loss attributable to noncontrolling interest

 
(2,101
)
 
(1,962
)
Net income attributable to Mentor Graphics shareholders
$
154,866

 
$
96,277

 
$
147,139

Net income per share:
 
 
 
 
 
Basic
$
1.42

 
$
0.83

 
$
1.28

Diluted
$
1.37

 
$
0.81

 
$
1.26

Weighted average number of shares outstanding:
 
 
 
 
 
Basic
108,795

 
116,701

 
114,635

Diluted
114,322

 
119,263

 
117,078

Cash dividends declared per common share
$
0.22

 
$
0.22

 
$
0.20

See accompanying notes to consolidated financial statements.


37


Mentor Graphics Corporation
Consolidated Statements of Comprehensive Income
Fiscal year ended January 31,
2017
 
2016
 
2015
In thousands
 
 
 
 
 
Net income
$
154,866

 
$
94,176

 
$
145,177

Other comprehensive loss, net of tax:
 
 
 
 
 
Change in accumulated translation adjustment
(4,448
)
 
(8,947
)
 
(30,360
)
Change in unrealized gain (loss) on derivative instruments
16

 
(78
)
 

Change in pension liability
(33
)
 
(166
)
 
(285
)
Other comprehensive loss
(4,465
)
 
(9,191
)
 
(30,645
)
Comprehensive income
150,401

 
84,985

 
114,532

Less amounts attributable to the noncontrolling interest:
 
 
 
 
 
Net loss

 
(2,101
)
 
(1,962
)
Change in accumulated translation adjustment

 
22

 
45

Comprehensive loss attributable to the noncontrolling interest

 
(2,079
)
 
(1,917
)
Comprehensive income attributable to Mentor Graphics shareholders
$
150,401

 
$
87,064

 
$
116,449


See accompanying notes to consolidated financial statements.


38


Mentor Graphics Corporation
Consolidated Balance Sheets
As of January 31,
2017
 
2016
In thousands
 
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
441,087

 
$
334,826

Trade accounts receivable, net of allowance for doubtful accounts of $4,089 as of January 31, 2017 and $3,826 as of January 31, 2016
512,644

 
493,209

Other receivables
18,803

 
23,120

Inventory
18,575

 
24,762

Prepaid expenses and other
32,742

 
22,550

Total current assets
1,023,851

 
898,467

Property, plant, and equipment, net
210,680

 
182,092

Term receivables
303,686

 
268,657

Goodwill
611,536

 
606,842

Intangible assets, net
31,813

 
37,446

Other assets
79,619

 
70,860

Total assets
$
2,261,185

 
$
2,064,364

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Short-term borrowings
$
31,717

 
$
33,449

Current portion of notes payable (Note 7)
242,921

 

Accounts payable
16,454

 
16,740

Income taxes payable
10,150

 
3,966

Accrued payroll and related liabilities
116,521

 
73,371

Accrued and other liabilities
50,695

 
37,059

Deferred revenue
294,297

 
258,725

Total current liabilities
762,755

 
423,310

Notes payable (Note 7)
5,188

 
240,076

Deferred revenue
40,196

 
18,303

Income tax liability
23,518

 
25,116

Other long-term liabilities
43,809

 
37,130

Total liabilities
875,466

 
743,935

Commitments and contingencies (Note 9)

 

Convertible notes (Note 7)
10,036

 

Stockholders’ equity:
 
 
 
Common stock, no par value, 300,000 shares authorized as of January 31, 2017 and January 31, 2016; 110,383 shares issued and outstanding as of January 31, 2017 and 114,934 shares issued and outstanding as of January 31, 2016
737,164

 
818,683

Retained earnings
664,084

 
522,846

Accumulated other comprehensive loss
(25,565
)
 
(21,100
)
Total stockholders’ equity
1,375,683

 
1,320,429

Total liabilities and stockholders’ equity
$
2,261,185

 
$
2,064,364

See accompanying notes to consolidated financial statements.

39


Mentor Graphics Corporation
Consolidated Statements of Cash Flows
Fiscal year ended January 31,
2017
 
2016
 
2015
In thousands
 
 
 
 
 
Operating Cash Flows:
 
 
 
 
 
Net income
$
154,866

 
$
94,176

 
$
145,177

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation of property, plant, and equipment
39,867

 
36,449

 
34,336

Amortization of intangible assets, debt costs and other
21,980

 
24,973

 
23,710

Stock-based compensation
46,793

 
40,497

 
35,807

Deferred income taxes
12,332

 
5,055

 
9,265

Changes in other long-term liabilities
2,620

 
(804
)
 
876

Equity in income of unconsolidated entities, net of dividends received
1,267

 
(455
)
 
507

Other
98

 
(696
)
 
85

Changes in operating assets and liabilities, net of effect of acquired businesses:
 
 
 
 
 
Trade accounts receivable, net
(22,694
)
 
49,751

 
(90,404
)
Prepaid expenses and other
(8,028
)
 
(13,558
)
 
(16,348
)
Term receivables, long-term
(36,259
)
 
31,672

 
(34,808
)
Accounts payable and accrued liabilities
47,114

 
(37,519
)
 
4,832

Income taxes receivable and payable
3,320

 
3,984

 
1,722

Deferred revenue
58,535

 
(2,275
)
 
26,082

Net cash provided by operating activities
321,811

 
231,250

 
140,839

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

 

 
4,124

Proceeds from sale of building

 
2,068

 

Purchases of property, plant, and equipment
(60,288
)
 
(43,336
)
 
(48,366
)
Acquisitions of businesses and equity interests, net
(11,759
)
 
(11,700
)
 
(84,596
)
Net cash used in investing activities
(72,047
)
 
(52,968
)
 
(128,838
)
Financing Cash Flows:
 
 
 
 
 
Proceeds from issuance of common stock
32,490

 
32,807

 
29,990

Repurchase of common stock
(146,050
)
 
(85,000
)
 
(70,053
)
Payments related to tax withholding on vesting of share based awards
(4,716
)
 
(2,437
)
 
(2,351
)
Dividends paid
(23,808
)
 
(25,590
)
 
(22,911
)
Net increase (decrease) in short-term borrowing, excluding revolving credit facility
3,236

 
1,190

 
(2,660
)
Proceeds from revolving credit facility

 
25,000

 

Repayments of revolving credit facility
(5,000
)
 

 

Repayments of other borrowings
(1,475
)
 
(7,268
)
 
(3,659
)
Purchase of remaining noncontrolling interest in majority owned subsidiaries

 
(11,270
)
 

Proceeds (payments) for the sale of subsidiary shares from (to) noncontrolling interest

 
7

 
(41
)
Net cash used in financing activities
(145,323
)
 
(72,561
)
 
(71,685
)
Effect of exchange rate changes on cash and cash equivalents
1,820

 
(1,176
)
 
(3,357
)
Net change in cash and cash equivalents
106,261

 
104,545

 
(63,041
)
Cash and cash equivalents at the beginning of the period
334,826

 
230,281

 
293,322

Cash and cash equivalents at the end of the period
$
441,087

 
$
334,826

 
$
230,281

See accompanying notes to consolidated financial statements.

40


Mentor Graphics Corporation
Consolidated Statements of Stockholders’ Equity
 
Common Stock
 
Retained Earnings
 
Accumulated Other
Comprehensive
Income (Loss)
 
Noncontrolling Interest
 
Total
Stockholders’
Equity
 
Noncontrolling
Interest with
Redemption 
Feature
 
Shares
 
Amount
 
 
 
 
 
In thousands
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of January 31, 2014
115,722

 
$
838,939

 
$
327,552

 
$
18,803

 
$

 
$
1,185,294

 
$
15,479

Net income (loss)
 
 
 
 
147,139

 
 
 
29

 
147,168

 
(1,991
)
Other comprehensive income (loss)
 
 
 
 
 
 
(30,690
)
 
(1
)
 
(30,691
)
 
46

Recognition of noncontrolling interest
 
 
 
 
 
 
 
 
200

 
200

 
 
Adjustment of noncontrolling interest to redemption value
 
 
 
 
121